Is Drive Shack (NYSE:DS) Using Debt In A Risky Way?
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.' 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 can see that Drive Shack Inc. (NYSE:DS) does use debt in its business. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
See our latest analysis for Drive Shack
What Is Drive Shack's Net Debt?
The image below, which you can click on for greater detail, shows that Drive Shack had debt of US$60.2m at the end of December 2021, a reduction from US$63.9m over a year. However, its balance sheet shows it holds US$63.6m in cash, so it actually has US$3.35m net cash.
How Healthy Is Drive Shack's Balance Sheet?
According to the last reported balance sheet, Drive Shack had liabilities of US$110.7m due within 12 months, and liabilities of US$342.2m due beyond 12 months. Offsetting this, it had US$63.6m in cash and US$24.9m in receivables that were due within 12 months. So its liabilities total US$364.5m more than the combination of its cash and short-term receivables.
The deficiency here weighs heavily on the US$112.4m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. At the end of the day, Drive Shack would probably need a major re-capitalization if its creditors were to demand repayment. Given that Drive Shack has more cash than debt, we're pretty confident it can handle its debt, despite the fact that it has a lot of liabilities in total. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Drive Shack 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.
In the last year Drive Shack wasn't profitable at an EBIT level, but managed to grow its revenue by 28%, to US$282m. Shareholders probably have their fingers crossed that it can grow its way to profits.
So How Risky Is Drive Shack?
Statistically speaking companies that lose money are riskier than those that make money. And the fact is that over the last twelve months Drive Shack lost money at the earnings before interest and tax (EBIT) line. And over the same period it saw negative free cash outflow of US$32m and booked a US$37m accounting loss. Given it only has net cash of US$3.35m, the company may need to raise more capital if it doesn't reach break-even soon. With very solid revenue growth in the last year, Drive Shack may be on a path to profitability. By investing before those profits, shareholders take on more risk in the hope of bigger rewards. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 4 warning signs for Drive Shack (2 don't sit too well with us!) that you should be aware of before investing here.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
