Warren Buffett famously said, ‘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. As with many other companies Future Gaming Group International AB (publ) (NGM:FGG) makes use of debt. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
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. Part and parcel of capitalism is the process of ‘creative destruction’ where failed businesses are mercilessly liquidated by their bankers. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company’s debt levels is to consider its cash and debt together.
What Is Future Gaming Group International’s Debt?
The image below, which you can click on for greater detail, shows that at June 2021 Future Gaming Group International had debt of kr127.3m, up from kr117.9m in one year. However, it does have kr12.5m in cash offsetting this, leading to net debt of about kr114.8m.
How Healthy Is Future Gaming Group International’s Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Future Gaming Group International had liabilities of kr129.9m due within 12 months and liabilities of kr308.0k due beyond that. Offsetting these obligations, it had cash of kr12.5m as well as receivables valued at kr3.20m due within 12 months. So its liabilities total kr114.5m more than the combination of its cash and short-term receivables.
This deficit casts a shadow over the kr28.8m company, like a colossus towering over mere mortals. So we’d watch its balance sheet closely, without a doubt. After all, Future Gaming Group International would likely require a major re-capitalisation if it had to pay its creditors today.
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 0.63 times and a disturbingly high net debt to EBITDA ratio of 22.4 hit our confidence in Future Gaming Group International like a one-two punch to the gut. The debt burden here is substantial. Worse, Future Gaming Group International’s EBIT was down 38% over the last year. If earnings keep going like that over the long term, it has a snowball’s chance in hell of paying off that debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is Future Gaming Group International’s earnings that will influence how the balance sheet holds up in the future. So when considering debt, it’s definitely worth looking at the earnings trend. Click here for an interactive snapshot.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Future Gaming Group International burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.
On the face of it, Future Gaming Group International’s EBIT growth rate left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. And furthermore, its interest cover also fails to instill confidence. Considering everything we’ve mentioned above, it’s fair to say that Future Gaming Group International is carrying heavy debt load. If you harvest honey without a bee suit, you risk getting stung, so we’d probably stay away from this particular stock. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we’ve identified 4 warning signs for Future Gaming Group International (2 are a bit concerning) you should be aware of.
When all is said and done, sometimes its easier to focus on companies that don’t even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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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.