Here’s why Callaway Golf (NYSE:ELY) has significant debt

Howard Marks said it well when he said that, rather than worrying about stock price volatility, “the possibility of permanent loss is the risk I worry about…and that every practical investor that I know is worried”. So it seems smart money knows that debt – which is usually involved in bankruptcies – is a very important factor when you’re assessing a company’s risk. We can see that Callaway Golf Company (NYSE:ELY) uses debt in its operations. But the more important question is: what risk does this debt create?

Why is debt risky?

Debt and other liabilities become risky for a business when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. If things go really bad, lenders can take over the business. Although not too common, we often see companies in debt permanently diluting their shareholders because lenders force them to raise capital at a ridiculous price. By replacing dilution, however, debt can be a great tool for companies that need capital to invest in growth at high rates of return. The first step when considering a company’s debt levels is to consider its cash and debt together.

Check out our latest analysis for Callaway Golf

What is Callaway Golf’s debt?

As you can see below, at the end of March 2022, Callaway Golf had $1.31 billion in debt, up from $1.22 billion a year ago. Click on the image for more details. However, since it has a cash reserve of $245.0 million, its net debt is lower, at around $1.06 billion.

NYSE: ELY Debt to Equity June 29, 2022

How strong is Callaway Golf’s balance sheet?

The latest balance sheet data shows Callaway Golf had liabilities of $1.16 billion due within the year, and liabilities of $3.22 billion due thereafter. In return, it had $245.0 million in cash and $468.4 million in receivables due within 12 months. It therefore has liabilities totaling $3.67 billion more than its cash and short-term receivables, combined.

This shortfall is sizable relative to its market capitalization of US$3.93 billion, so it suggests shareholders should monitor Callaway Golf’s use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet quickly.

In order to assess a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its expenses. interest (its interest coverage). The advantage of this approach is that we consider both the absolute amount of debt (with net debt to EBITDA) and the actual interest expense associated with that debt (with its interest coverage ratio ).

While Callaway Golf’s debt to EBITDA ratio (2.6) suggests it uses some debt, its interest coverage is very low at 1.8, suggesting high leverage. It seems clear that the cost of borrowing money is having a negative impact on shareholder returns lately. Above all, Callaway Golf has increased its EBIT by 68% over the last twelve months, and this growth will make it easier to manage its 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 Callaway Golf can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.

Finally, while the taxman may love accounting profits, lenders only accept cash. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, Callaway Golf has actually had a cash outflow, overall. Debt is much riskier for companies with unreliable free cash flow, so shareholders must hope that past spending will produce free cash flow in the future.

Our point of view

At first glance, Callaway Golf’s EBIT to free cash flow conversion left us hesitant about the stock, and its interest coverage was no more appealing than the single empty restaurant on the busiest night in the year. But on the bright side, its EBIT growth rate is a good sign and makes us more optimistic. Looking at the balance sheet and taking all of these factors into account, we think debt makes Callaway Golf stock a bit risky. This isn’t necessarily a bad thing, but we would generally feel more comfortable with less leverage. 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. For example – Callaway Golf has 1 warning sign we think you should know.

If, after all that, you’re more interested in a fast-growing company with a strong balance sheet, check out our list of cash-flowing growth stocks without further ado.

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.

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