Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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 Las Vegas Sands Corp. (NYSE:LVS) 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 and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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.
How Much Debt Does Las Vegas Sands Carry?
The image below, which you can click on for greater detail, shows that at June 2019 Las Vegas Sands had debt of US$12.0b, up from US$11.3b in one year. However, it does have US$4.02b in cash offsetting this, leading to net debt of about US$7.98b.
How Strong Is Las Vegas Sands's Balance Sheet?
The latest balance sheet data shows that Las Vegas Sands had liabilities of US$3.03b due within a year, and liabilities of US$13.0b falling due after that. On the other hand, it had cash of US$4.02b and US$767.0m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$11.2b.
Las Vegas Sands has a very large market capitalization of US$44.6b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.
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.
Las Vegas Sands's net debt of 1.6 times EBITDA suggests graceful use of debt. And the alluring interest cover (EBIT of 8.0 times interest expense) certainly does not do anything to dispel this impression. But the other side of the story is that Las Vegas Sands saw its EBIT decline by 6.4% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. 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 Las Vegas Sands 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. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Las Vegas Sands recorded free cash flow worth a fulsome 87% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.
Happily, Las Vegas Sands's impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. But truth be told we feel its EBIT growth rate does undermine this impression a bit. All these things considered, it appears that Las Vegas Sands can comfortably handle its current debt levels. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. Given Las Vegas Sands has a strong balance sheet is profitable and pays a dividend, it would be good to know how fast its dividends are growing, if at all. You can find out instantly by clicking this link.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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If you spot an error that warrants correction, please contact the editor at email@example.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.