Legendary fund manager Li Lu (whom Charlie Munger once backed) once said, “The biggest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital. So it seems smart money knows that debt – which is usually involved in bankruptcies – is a very important factor when you’re assessing a company’s risk. We note that Enjoy SA (SNSE: ENJOY) has debt on its balance sheet. But the more important question is: what risk does this debt create?
When is debt dangerous?
Debt helps a business until the business struggles to pay it back, either with new capital or with free cash flow. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. Although not too common, we often see companies in debt permanently diluting their shareholders because lenders force them to raise capital at a ridiculous price. Of course, many companies use debt to finance their growth, without any negative consequences. The first thing to do when considering how much debt a business has is to look at its cash and debt together.
See our latest analysis for Enjoy
What is Enjoy’s debt?
As you can see below, at the end of June 2022, Enjoy had CL$249.9 billion in debt, up from CL$186.2 billion a year ago. Click on the image for more details. However, he has CL$36.2 billion in cash to offset this, resulting in a net debt of approximately CL$213.6 billion.
A Look at Enjoy’s Responsibilities
Zooming in on the latest balance sheet data, we can see that Enjoy had liabilities of CL$158.6 billion due within 12 months and liabilities of CL$547.6 billion due beyond. In return, it had CL$36.2 billion in cash and CL$30.4 billion in receivables due within 12 months. It therefore has liabilities totaling CL$639.6 billion more than its cash and short-term receivables, combined.
This deficit casts a shadow over the CL$84.1 billion company, like a colossus towering above mere mortals. So we definitely think shareholders need to watch this one closely. After all, Enjoy would probably need a major recapitalization if it had to pay its creditors today.
In order to assess a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its expenses. interest (its interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
While we’re not concerned about Enjoy’s net debt to EBITDA ratio of 4.2, we believe its extremely low interest coverage of 0.38x is a sign of high leverage. This is largely due to the company’s large amortization charges, which no doubt means that its EBITDA is a very generous measure of earnings, and that its debt may be heavier than it first appears. on board. Shareholders should therefore probably be aware that interest charges seem to have had a real impact on the company lately. A redeeming factor for Enjoy is that it turned last year’s EBIT loss into a CL$16 billion gain, over the past twelve months. When analyzing debt levels, the balance sheet is the obvious starting point. But it is the profits of Enjoy that will influence the balance sheet in the future. So, when considering debt, it is definitely worth looking at the earnings trend. Click here for an interactive preview.
But our last consideration is also important, because a company cannot pay debt with paper profits; he needs cash. It is therefore important to check how much of its earnings before interest and taxes (EBIT) converts into actual free cash flow. Over the past year, Enjoy has burned a lot of money. While investors no doubt expect a reversal of this situation in due course, it clearly means that its use of debt is more risky.
Our point of view
To be frank, Enjoy’s EBIT to free cash flow conversion and track record of keeping its total liabilities under control makes us rather uncomfortable with its level of leverage. That said, its ability to grow its EBIT is not such a concern. After reviewing the data points discussed, we believe that Enjoy has too much debt. While some investors like this kind of risky play, it’s definitely not our cup of tea. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risks reside on the balance sheet, far from it. Example: we have identified 5 warning signs for Enjoy you should know, and 3 of them make us uncomfortable.
In the end, it’s often best to focus on companies that aren’t in debt. You can access our special list of these companies (all with a track record of earnings growth). It’s free.
Feedback on this article? Concerned about content? Get in touch with us directly. You can also email the editorial team (at) Simplywallst.com.
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.
Calculation of discounted cash flows for each share
Simply Wall St performs a detailed calculation of discounted cash flow every 6 hours for every stock in the market, so if you want to find the intrinsic value of any company, just search here. It’s free.