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.
Las Vegas Sands
Wynn Resorts (NAS: WYNN)
Melco Crown Entertainment (NAS: MPEL)
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.
Interest Coverage Ratio
Las Vegas Sands
Melco Crown Entertainment
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.
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