Berkshire Hathaway’s Charlie Munger-backed outside fund manager Li Lu is quick to say, “The biggest risk in investing isn’t price volatility, but whether you’re going to suffer a permanent loss of capital “. When we think of a company’s risk, we always like to look at its use of debt, because over-indebtedness can lead to ruin. Like many other companies Shift4 Payments, Inc. (NYSE:FOUR) uses debt. But the more important question is: what risk does this debt create?
When is debt a problem?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. 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, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business has is to look at its cash and debt together.
Check out 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 June 2022, Shift4 Payments had $1.74 billion in debt, an increase from $1.12 billion, year-over-year . However, he also had $1.02 billion in cash, so his net debt is $719.6 million.
How healthy is Shift4 Payments’ balance sheet?
The latest balance sheet data shows that Shift4 Payments had liabilities of US$275.3 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$1.02 billion as well as receivables valued at US$253.1 million due within 12 months. It therefore has liabilities totaling $760.9 million more than its cash and short-term receivables, combined.
Given that publicly traded Shift4 Payments shares are worth a total of US$3.83 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 1.3x and an extremely high net debt to EBITDA ratio of 6.7 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$41 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 future revenues, more than anything, will determine Shift4 Payments’ ability to maintain a healthy balance sheet in the future. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
Finally, a business needs free cash flow to pay off its debts; book profits are not enough. 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 experienced substantial negative free cash flow, overall. While this may be the result of spending for growth, it makes debt much riskier.
Our point of view
To be frank, Shift4 Payments’ net debt to EBITDA ratio and history of converting EBIT to free cash flow makes us rather uncomfortable with its leverage levels. That said, his ability to manage his total liabilities isn’t all that worrying. Overall, we think it’s fair to say that Shift4 Payments has enough debt that there is real risk around the balance sheet. If all goes well, it can pay off, but the downside of this debt is a greater risk of permanent losses. Given our reservations about the company’s balance sheet, it seems a good idea to check whether any insiders have sold shares recently.
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.
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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.
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