This Company Is Drowning in Debt

Before you go, we thought you'd like these...
Before you go close icon

Earlier this year, the largest casino operator in the United States, Caesars Entertainment (NYS: CZR) , went public in a highly anticipated IPO. Since then, however, its stock has lost nearly a third of its value, leaving investors wondering whether they placed their bets at the wrong table.

The reason for the company's lackluster performance is simple: It's drowning in debt. To see why this is so and unravel what it means for Caesars going forward, I take a look at the state of the company's leverage and liquidity.

How leveraged is Caesars?
The most common way to measure leverage is the debt-to-equity ratio. This is calculated by dividing the total amount of a company's debt by the amount of its shareholder's equity. The quotient represents the proportion of a company's capital structure that consists of debt. A ratio of one means that half the structure is from debt and half is from equity. A number greater than one means the company's capital structure consists predominantly of debt. And a number less than one means it consists predominantly of equity.

In this case, Caesars' debt-to-equity ratio is 16.89, meaning it has nearly 17 times more debt on its balance sheet than equity. As you can see in the table below, this makes it the most highly leveraged company in the gaming industry. Its debt burden alone is nearly twice that of Las Vegas Sands (NYS: LVS) , even though the latter records 10% more in revenue each year and has seven times as much equity.

Company

Debt

Equity

Debt/Equity Ratio

Caesars

$19,621

$1,162

16.89

Las Vegas Sands

$10,033

$7,851

1.28

Wynn Resorts (NAS: WYNN)

$3,218

$2,089

1.54

Melco Crown Entertainment (NAS: MPEL)

$2,321

$2,731

0.95

Morningstar.com. All figures are in millions and correspond to the most recent quarter.

To make matters worse, all of Caesars' equity is made up of intangible assets. On its most recent quarterly filing, the company recorded $3.5 billion in goodwill and $4.7 billion in other intangible assets. Once you remove these, its tangible equity is negative to the tune of $7 billion. This is akin to having a $200,000 mortgage on a house that's worth only $130,000.

Can Caesars service its debt?
The most common way to determine this is the interest coverage ratio. This is the amount of operating income a company generates compared to the size of its interest payment. If the interest payments are high relative to operating income, then the slightest economic shock could send the company into trouble. As a rule of thumb, we like to see interest coverage ratios in the high single digits or higher. Anything below five is a sign of trouble, and anything below one typically can't be sustained for an extended period of time.

Company

Interest Payments

Operating Income

Interest Coverage Ratio

Las Vegas Sands

$283

$2,378

8.40

Wynn Resorts

$230

$1,035

4.50

Melco Crown Entertainment

$115

$316

2.75

Caesars

$1,958

$940

0.48

Morningstar.com. All figures are in millions and correspond to the trailing-12-months time period.

Besides leaving a company like Caesars vulnerable in economic shocks, onerous interest payments like these crowd out investment in property, plant, and equipment. In a report issued last June, for instance, Moody's credit rating agency noted that "Caesars' significant debt service burden leaves the company with insufficient free cash flow for maintenance of existing assets. We believe this makes Caesars' properties prone to market share loss over the intermediate term."

Caesars itself commented on this in its most recent quarterly filing: "We cannot assure you that our business will generate sufficient cash flows from operations, or that future borrowings will be available to us, to fund our liquidity needs and pay our indebtedness. If we are unable to meet our liquidity needs or pay our indebtedness when it is due, we may have to reduce or delay refurbishment and expansion projects, reduce expenses, sell assets or attempt to restructure our debt."

Avoid this stock at all costs
If I haven't made it clear in the discussion above, let me do so now. While I enjoy a casino as much as the next man, I wouldn't touch Caesars' stock with a 10-foot pole. In my opinion, its debt burden and interest payments place it beyond the pale of a legitimate long-term investment and call into question the company's ability to grow its revenue and increase profits going forward. Indeed, if I were thinking about placing a wager on Caesars, I'd just as soon head to one of its casinos. Free drinks always lessen the pain of losing.

For a stock with much better odds of paying off both this year and going forward, check out our recently released free report "The Motley Fool's Top Stock for 2012." It details an up-and-coming company that our chief investment officer handpicked for The Motley Fool investing community. While it's impossible to predict how far this stock will soar over the next 12 months, it's bound to be an excellent year for this company's shareholders. To learn the identity of this company, you can access this limited time free report by clicking here now -- it's absolutely free.

At the time this article was published Fool contributor John Maxfield does not have a financial position in any of the companies mentioned above. Try any of our Foolish newsletter servicesfree for 30 days. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.

Copyright © 1995 - 2012 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

Read Full Story

Want more news like this?

Sign up for Finance Report by AOL and get everything from business news to personal finance tips delivered directly to your inbox daily!

Subscribe to our other newsletters

Emails may offer personalized content or ads. Learn more. You may unsubscribe any time.

From Our Partners