David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 can see that PENN Entertainment, Inc. (NASDAQ:PENN) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is PENN Entertainment's Net Debt?

As you can see below, PENN Entertainment had US$2.76b of debt, at June 2024, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has US$877.6m in cash leading to net debt of about US$1.88b.

A Look At PENN Entertainment's Liabilities

Zooming in on the latest balance sheet data, we can see that PENN Entertainment had liabilities of US$1.30b due within 12 months and liabilities of US$11.2b due beyond that. Offsetting this, it had US$877.6m in cash and US$251.9m in receivables that were due within 12 months. So it has liabilities totalling US$11.4b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the US$2.70b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, PENN Entertainment would probably need a major re-capitalization if its creditors were to demand repayment.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

While PENN Entertainment's debt to EBITDA ratio (3.9) suggests that it uses some debt, its interest cover is very weak, at 0.12, suggesting high leverage. In large part that's due to the company's significant depreciation and amortisation charges, which arguably mean its EBITDA is a very generous measure of earnings, and its debt may be more of a burden than it first appears. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. Worse, PENN Entertainment's EBIT was down 95% over the last year. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if PENN Entertainment can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Looking at the most recent three years, PENN Entertainment recorded free cash flow of 39% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

To be frank both PENN Entertainment'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 at least its conversion of EBIT to free cash flow is not so bad. Taking into account all the aforementioned factors, it looks like PENN Entertainment has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. Given our concerns about PENN Entertainment's debt levels, it seems only prudent to check if insiders have been ditching the stock.

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.