Is Repay Holdings (NASDAQ:RPAY) Using Too Much Debt?
Simply Wall St March 10, 2020
Howard Marks put it nicely when he said that, rather than worrying about share price volatility, ‘The possibility of permanent loss is the risk I worry about… and every practical investor I know worries about. When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Repay Holdings Corporation (NASDAQ:RPAY) does use debt in its business. But the more important question is: how much risk is that debt creating?
When Is Debt A Problem?
Generally speaking, debt only becomes a real problem when a company can’t easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company’s debt levels is to consider its cash and debt together.
How Much Debt Does Repay Holdings Carry?
At the end of September 2019, Repay Holdings had US$204.2m of debt, up from US$94.2m a year ago. However, because it has a cash reserve of US$45.5m, its net debt is less, at about US$158.7m.
How Strong Is Repay Holdings’s Balance Sheet?
Repay Holdings had liabilities of US$34.9m due within 12 months and liabilities of US$265.9m due beyond that. Offsetting this, it had US$45.5m in cash and US$12.6m in receivables that were due within 12 months. So its liabilities total US$242.6m more than the combination of its cash and short-term receivables.
Since publicly traded Repay Holdings shares are worth a total of US$1.23b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.
In order to size up a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
Repay Holdings’s debt is 3.8 times its EBITDA, and its EBIT cover its interest expense 3.0 times over. This suggests that while the debt levels are significant, we’d stop short of calling them problematic. The good news is that Repay Holdings grew its EBIT a smooth 46% over the last twelve months. Like the milk of human kindness that sort of growth increases resilience, making the company more capable of managing debt.
When analyzing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Repay Holdings’s ability to maintain a healthy balance sheet going forward.
Finally, a business needs free cash flow to pay off debt; accounting profits just don’t cut it. So it’s worth checking how much of that EBIT is backed by free cash flow. Over the most recent three years, Repay Holdings recorded free cash flow worth 75% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.
Our View
The good news is that Repay Holdings’s demonstrated ability to grow its EBIT delights us like a fluffy puppy does a toddler. But we must concede we find its interest cover has the opposite effect. When we consider the range of factors above, it looks like Repay Holdings is pretty sensible with its use of debt. While that brings some risk, it can also enhance returns for shareholders. The balance sheet is clearly the area to focus on when you are analyzing debt. However, not all investment risk resides within the balance sheet – far from it. Consider risks, for instance. Every company has them, and we’ve spotted 1 warning sign for Repay Holdings you should know about.
If you’re interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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