Entertainment Ones(LSE: ETO) shares have been on a wild ride this week. On Monday, the shares lost 14%. On Tuesday, the companys shares slumped 21% but today, the shares are rallying and have gained 11.4% at time of writing.
Entertainment One is rising today after the companys management attempted to reassure shareholders this morning. In a trading update, management announced that the group continues to trade in line with full-year earnings expectations. Whats more, the trading update reassured investors that the companycontinues to have confidence in its target of doubling the size of the business by 2020, with strong organic growth and carefully targeted acquisitions.
Alongside this positive statement, Entertainment One announced thatDarren Throop, chief executive had spent 183,000 buying just under 140,000 shares in the company during Tuesdays carnage.
Underlying concerns
However, while the director dealing and upbeat trading statement from Entertainment One have been received well by the market, they fail to address the underlying concerns that have weighed on the groups shares for the last six months.
Specifically, the market is concerned aboutEntertainment Ones lack of astable and predictable passage of trading. In other words, while the group has had some success with its childrens animation Peppa Pig, and thedistribution of zombie drama Fear the Walking Dead, the group is struggling to generate long-term sustainable growth. Granted, City analysts expectEntertainment Ones revenue to increase 3.4% year-on-year to 813m for the year ending 31/03/2016, but this is still 1.2% below the sales figure of 823m reported two years ago.
A more concerningmetric isEntertainment Ones rising cost of debt.The company announced on Friday that it is raising in 285m in new debt to replace existing facilities. This new seven-year debt will have an interest rate of6.9%. Entertainment Ones current debt has an interest rate of only 4.3%. The higher cost of debt could be a reflection of wider market trends, or it could indicate that debt investors dont trust the companys financial projections.
Whatever the case, its clear that debt investors are now more cautious about lending to Entertainment One than they have been in the past and its easy to see why. According to credit rating agency Moodys, at the end of the first quarterEntertainment Ones adjusted gross debt was about three-and-a-half times earnings before interest, taxation, depreciation and amortisation (EBITDA). A debt to EBITDA ratio of more than two is usually considered to be a cause for concern. The companys financing costs nearly doubled in the six months to September.
The bottom line
So overall,Darren Throop may be willing to put his money where his mouth is and back Entertainment One, but if you dont already own the companys shares, it might be wise to stay away. With debt increasing and no clear path for growth, Entertainment One is hardly a top pick for me.
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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.
