Is Kennedy-Wilson Holdings (NYSE:KW) A Risky Investment?
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. Importantly, Kennedy-Wilson Holdings, Inc. (NYSE:KW) does carry debt. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
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. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.
See our latest analysis for Kennedy-Wilson Holdings
What Is Kennedy-Wilson Holdings's Net Debt?
The image below, which you can click on for greater detail, shows that Kennedy-Wilson Holdings had debt of US$5.18b at the end of June 2019, a reduction from US$5.54b over a year. However, it also had US$404.0m in cash, and so its net debt is US$4.78b.
How Strong Is Kennedy-Wilson Holdings's Balance Sheet?
The latest balance sheet data shows that Kennedy-Wilson Holdings had liabilities of US$510.6m due within a year, and liabilities of US$5.20b falling due after that. Offsetting these obligations, it had cash of US$404.0m as well as receivables valued at US$140.6m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$5.16b.
This deficit casts a shadow over the US$2.94b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt At the end of the day, Kennedy-Wilson Holdings would probably need a major re-capitalization if its creditors were to demand repayment.
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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Weak interest cover of 0.15 times and a disturbingly high net debt to EBITDA ratio of 21.9 hit our confidence in Kennedy-Wilson Holdings like a one-two punch to the gut. The debt burden here is substantial. Even worse, Kennedy-Wilson Holdings saw its EBIT tank 45% over the last 12 months. 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 it is future earnings, more than anything, that will determine Kennedy-Wilson Holdings's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Kennedy-Wilson Holdings actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.
Our View
To be frank both Kennedy-Wilson Holdings's EBIT growth rate and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. Taking into account all the aforementioned factors, it looks like Kennedy-Wilson Holdings has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. Given our concerns about Kennedy-Wilson 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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If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.
