A reader in the gaming industry asked me about Shuffle Master Inc (NASDAQ: SHFL). For all I know, Shuffle Master may make the best gaming products in the industry, supplying casinos with electronic tables, automatic shufflers, chip sorters and other gaming products. But for various reasons, we wouldn't go near this stock for our portfolio.
First, this company only has $155 million in tangible assets, but it's financed with debt of $222 million! For a value investor, this screams of risk. If hard times should hit this company, it is in no position to meet its obligations, and this would obliterate the value of its shares. As discussed here, we like companies with low debt levels that can outlast their competition when times are bad.
Exacerbating this issue is the fact that $150 million of that debt is due within the next 12 months, while the company has only $93 million in current assets. That leaves them in a bit of a liquidity crunch. That's not to say that they won't be able to refinance, but considering the economic climate, the terms of such a refinance may not be that pretty for shareholders.
But can this company earn its way out of this debt situation? It's possible, if this company can grow its revenue or cut its expenses. But such a scenario is not something we value investors would like to bet on. We're much more comfortable assuming management can generate the types of returns on capital that it has in the past.
The company's return on assets for the last couple of years is below 5%. At those rates of return, I'm not too excited about letting management re-invest my earnings, but that's exactly what they'd do, as they pay no dividend and, considering their debt levels, they are in no position to be able to either!
All in all, this company doesn't even make it to the valuation stage. Unfortunately, we're pretty discriminating in our choice of companies.