David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Camping World Holdings, Inc. (NYSE:CWH) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Camping World Holdings's Net Debt?
The chart below, which you can click on for greater detail, shows that Camping World Holdings had US$2.04b in debt in June 2019; about the same as the year before. However, it does have US$101.3m in cash offsetting this, leading to net debt of about US$1.94b.
How Strong Is Camping World Holdings's Balance Sheet?
According to the last reported balance sheet, Camping World Holdings had liabilities of US$1.41b due within 12 months, and liabilities of US$2.23b due beyond 12 months. Offsetting these obligations, it had cash of US$101.3m as well as receivables valued at US$218.4m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$3.33b.
This deficit casts a shadow over the US$747.9m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Camping World Holdings would likely require a major re-capitalisation if it had to pay its creditors today.
We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Weak interest cover of 1.7 times and a disturbingly high net debt to EBITDA ratio of 7.9 hit our confidence in Camping World Holdings like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. Worse, Camping World Holdings's EBIT was down 40% over the last year. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Camping World Holdings can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. In the last three years, Camping World Holdings created free cash flow amounting to 13% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.
On the face of it, Camping World Holdings's EBIT growth rate left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. And even its interest cover fails to inspire much confidence. We think the chances that Camping World Holdings has too much debt a very significant. To our minds, that means the stock is rather high risk, and probably one to avoid; but to each their own (investing) style. Given our concerns about Camping World Holdings's debt levels, it seems only prudent to check if insiders have been ditching the stock.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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