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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Accel Entertainment, Inc. (NYSE:ACEL) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

How Much Debt Does Accel Entertainment Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Accel Entertainment had US$554.1m of debt, an increase on US$512.5m, over one year. However, it does have US$272.2m in cash offsetting this, leading to net debt of about US$281.9m.

How Strong Is Accel Entertainment's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Accel Entertainment had liabilities of US$119.4m due within 12 months and liabilities of US$624.1m due beyond that. On the other hand, it had cash of US$272.2m and US$7.83m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$463.5m.

This deficit isn't so bad because Accel Entertainment is worth US$1.02b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Accel Entertainment's net debt is sitting at a very reasonable 1.7 times its EBITDA, while its EBIT covered its interest expense just 2.8 times last year. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. Sadly, Accel Entertainment's EBIT actually dropped 9.5% in the last year. If earnings continue on that decline then managing that debt will be difficult like delivering hot soup on a unicycle. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Accel Entertainment's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. Over the most recent three years, Accel Entertainment recorded free cash flow worth 62% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

While Accel Entertainment's EBIT growth rate makes us cautious about it, its track record of covering its interest expense with its EBIT is no better. At least its conversion of EBIT to free cash flow gives us reason to be optimistic. We think that Accel Entertainment's debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Accel Entertainment (of which 1 is potentially serious!) you should know about.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.