Here's Why Club Hipico de Santiago (SNSE:HIPICO) Can Afford Some Debt

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Club Hipico de Santiago S.A. (SNSE:HIPICO) does use debt in its business. But the more important question is: how much risk is that debt creating?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Club Hipico de Santiago

How Much Debt Does Club Hipico de Santiago Carry?

The image below, which you can click on for greater detail, shows that at December 2020 Club Hipico de Santiago had debt of CL$2.13b, up from CL$1.65b in one year. However, it does have CL$1.26b in cash offsetting this, leading to net debt of about CL$865.7m.

How Healthy Is Club Hipico de Santiago's Balance Sheet?

The latest balance sheet data shows that Club Hipico de Santiago had liabilities of CL$4.98b due within a year, and liabilities of CL$9.58b falling due after that. Offsetting this, it had CL$1.26b in cash and CL$1.59b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CL$11.7b.

This deficit isn't so bad because Club Hipico de Santiago is worth CL$21.0b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. When analysing debt levels, the balance sheet is the obvious place to start. But it is Club Hipico de Santiago's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year Club Hipico de Santiago had a loss before interest and tax, and actually shrunk its revenue by 33%, to CL$7.8b. That makes us nervous, to say the least.

Caveat Emptor

Not only did Club Hipico de Santiago's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). To be specific the EBIT loss came in at CL$2.0b. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. We would feel better if it turned its trailing twelve month loss of CL$1.6b into a profit. So to be blunt we do think it is risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example Club Hipico de Santiago has 2 warning signs (and 1 which is potentially serious) we think you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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