Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk. When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Groupon, Inc. (NASDAQ:GRPN) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.
What Is Groupon's Debt?
As you can see below, Groupon had US$208.1m of debt at June 2019, down from US$232.4m a year prior. However, it does have US$596.8m in cash offsetting this, leading to net cash of US$388.7m.
A Look At Groupon's Liabilities
The latest balance sheet data shows that Groupon had liabilities of US$749.7m due within a year, and liabilities of US$383.4m falling due after that. On the other hand, it had cash of US$596.8m and US$81.4m worth of receivables due within a year. So it has liabilities totalling US$454.8m more than its cash and near-term receivables, combined.
While this might seem like a lot, it is not so bad since Groupon has a market capitalization of US$1.56b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. While it does have liabilities worth noting, Groupon also has more cash than debt, so we're pretty confident it can manage its debt safely.
Also relevant is that Groupon has grown its EBIT by a very respectable 24% in the last year, thus enhancing its ability to pay down debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Groupon can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Groupon has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, Groupon actually produced more free cash flow than EBIT over the last two years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
While Groupon does have more liabilities than liquid assets, it also has net cash of US$388.7m. And it impressed us with free cash flow of US$34m, being 154% of its EBIT. So we don't think Groupon's use of debt is risky. We'd be motivated to research the stock further if we found out that Groupon insiders have bought shares recently. If you would too, then you're in luck, since today we're sharing our list of reported insider transactions for free.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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