Howard Marks said it well when he said that, rather than worrying about stock price volatility, “the possibility of permanent loss is the risk I worry about…and that every practical investor that I know is worried”. So it may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. We note that Shift4 Payments, Inc. (NYSE:FOUR) has debt on its balance sheet. But the real question is whether this debt makes the business risky.
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. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. That said, the most common situation is when a company manages its debt reasonably well – and to its own benefit. When we think about a company’s use of debt, we first look at cash and debt together.
See our latest analysis for Shift4 Payments
How much debt does Shift4 Payments have?
You can click on the graph below for historical numbers, but it shows that in March 2022, Shift4 Payments had $1.74 billion in debt, an increase from $1.12 billion, year-over-year . However, since he has a cash reserve of $1.19 billion, his net debt is less, at around $546.9 million.
A look at the liabilities of Shift4 Payments
The latest balance sheet data shows that Shift4 Payments had liabilities of US$258.8 million due within one year, and liabilities of US$1.76 billion falling due thereafter. As compensation for these obligations, it had cash of US$1.19 billion as well as receivables valued at US$225.5 million due within 12 months. It therefore has liabilities totaling $599.4 million more than its cash and short-term receivables, combined.
Given that publicly traded Shift4 Payments shares are worth a total of US$4.02 billion, it seems unlikely that this level of liability is a major threat. That said, it is clear that we must continue to monitor its record, lest it deteriorate.
We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). The advantage of this approach is that we consider both the absolute amount of debt (with net debt to EBITDA) and the actual interest expense associated with that debt (with its interest coverage ratio ).
A low interest coverage of 0.092x and an extremely high net debt to EBITDA ratio of 8.2 shook our confidence in Shift4 Payments like a punch in the gut. This means that we would consider him to be heavily indebted. However, the silver lining was that Shift4 Payments achieved a positive EBIT of US$2.7 million in the last twelve months, an improvement from the previous year’s loss. The balance sheet is clearly the area to focus on when analyzing debt. But ultimately, the company’s future profitability will decide whether Shift4 Payments can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
Finally, while the taxman may love accounting profits, lenders only accept cash. It is therefore worth checking how much of earnings before interest and tax (EBIT) is supported by free cash flow. Over the past year, Shift4 Payments has burned a lot of money. While investors no doubt expect a reversal of this situation in due course, this clearly means that its use of debt is more risky.
Our point of view
At first glance, Shift4 Payments’ interest coverage left us hesitant about the stock, and its EBIT to free cash flow conversion was no more appealing than the single empty restaurant on the busiest night in the year. That said, his ability to manage his total liabilities isn’t all that worrying. Looking at the big picture, it seems clear to us that Shift4 Payments’ use of debt creates risks for the business. If all goes well, it can pay off, but the downside of this debt is a greater risk of permanent losses. The balance sheet is clearly the area to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist outside of the balance sheet. For example, we found 2 warning signs for Shift4 Payments which you should be aware of before investing here.
If you are interested in investing in businesses that can generate profits without the burden of debt, then check out this free list of growing companies that have net cash on the balance sheet.
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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.