Here’s why Avaya Holdings (NYSE:AVYA) is weighed down by debt

Warren Buffett said: “Volatility is far from synonymous with risk. It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. Like many other companies Avaya Holdings Corp. (NYSE:AVYA) uses debt. But should shareholders worry about its use of debt?

When is debt dangerous?

Generally speaking, debt only becomes a real problem when a company cannot easily repay it, either by raising capital or with its own cash flow. If things go really bad, lenders can take over the business. However, a more common (but still costly) event is when a company has to issue stock at bargain prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, however, debt can be a great tool for companies that need capital to invest in growth at high rates of return. When we look at debt levels, we first consider cash and debt levels, together.

How much debt does Avaya Holdings have?

As you can see below, Avaya Holdings had $2.88 billion in debt as of September 2021, up from $3.00 billion the previous year. On the other hand, it has $498.0 million in cash, resulting in a net debt of around $2.38 billion.

NYSE: AVYA Debt to Equity History January 15, 2022

A look at the liabilities of Avaya Holdings

We can see from the most recent balance sheet that Avaya Holdings had liabilities of US$1.10 billion due in one year, and liabilities of US$4.37 billion due beyond. In return, it had $498.0 million in cash and $825.0 million in receivables due within 12 months. Thus, its liabilities outweigh the sum of its cash and (current) receivables by $4.14 billion.

This deficit casts a shadow over the $1.70 billion company, like a colossus towering above mere mortals. We would therefore be watching his balance sheet closely, no doubt. After all, Avaya Holdings would likely need a major recapitalization if it were to pay its creditors today.

We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.

While Avaya Holdings’ debt to EBITDA ratio (5.0) suggests it uses some debt, its interest coverage is very low at 1.1, suggesting high leverage. It seems clear that the cost of borrowing money is having a negative impact on shareholder returns lately. However, a redeeming factor is that Avaya Holdings has grown its EBIT by 14% over the past 12 months, strengthening its ability to manage debt. There is no doubt that we learn the most about debt from the balance sheet. But ultimately, the company’s future profitability will decide whether Avaya Holdings can strengthen its balance sheet over time. So if you are focused on the future, you can check out this free report showing analyst earnings forecasts.

Finally, while the taxman may love accounting profits, lenders only accept cash. It is therefore worth checking how much of this EBIT is supported by free cash flow. Over the past three years, Avaya Holdings has created free cash flow of 15% of EBIT, an uninspiring performance. This low level of cash conversion compromises its ability to manage and repay its debt.

Our point of view

To be frank, Avaya Holdings’ interest coverage and track record of keeping total liabilities under control makes us rather uncomfortable with its level of leverage. But at least it’s decent enough to increase its EBIT; it’s encouraging. Overall, it seems to us that Avaya Holdings’ balance sheet is really a risk for the business. For this reason, we are quite cautious about the stock and believe shareholders should keep a close eye on its liquidity. When analyzing debt levels, the balance sheet is the obvious starting point. But at the end of the day, every business can contain risks that exist outside of the balance sheet. We have identified 3 warning signs with Avaya Holdings (at least 2 that should not be overlooked) , and understanding them should be part of your investment process.

In the end, sometimes it’s easier to focus on companies that don’t even need to take on debt. Readers can access a list of growth stocks with no net debt 100% free, at present.

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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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John A. Bogar