The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Five Point Holdings, LLC (NYSE:FPH) makes use of debt. 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. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Five Point Holdings's Net Debt?
The image below, which you can click on for greater detail, shows that Five Point Holdings had debt of US$595.2m at the end of June 2019, a reduction from US$659.1m over a year. However, because it has a cash reserve of US$292.7m, its net debt is less, at about US$302.5m.
How Strong Is Five Point Holdings's Balance Sheet?
According to the last reported balance sheet, Five Point Holdings had liabilities of US$41.9m due within 12 months, and liabilities of US$926.4m due beyond 12 months. On the other hand, it had cash of US$292.7m and US$61.5m worth of receivables due within a year. So it has liabilities totalling US$614.1m more than its cash and near-term receivables, combined.
This deficit is considerable relative to its market capitalization of US$972.7m, so it does suggest shareholders should keep an eye on Five Point Holdings's use of debt. This suggests shareholders would heavily diluted if the company needed to shore up its balance sheet in a hurry. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Five Point Holdings's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
In the last year Five Point Holdings actually shrunk its revenue by 25%, to US$46m. To be frank that doesn't bode well.
While Five Point Holdings's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. To be specific the EBIT loss came in at US$76m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled US$347m in negative free cash flow over the last twelve months. So suffice it to say we consider the stock very risky. When I consider a company to be a bit risky, I think it is responsible to check out whether insiders have been reporting any share sales. Luckily, you can click here ito see our graphic depicting Five Point Holdings insider transactions.
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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