Leptos Calypso Hotels (CSE:LCH) Seems To Be Using A Lot Of Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 note that Leptos Calypso Hotels Public Ltd. (CSE:LCH) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Leptos Calypso Hotels

What Is Leptos Calypso Hotels's Debt?

The chart below, which you can click on for greater detail, shows that Leptos Calypso Hotels had €51.5m in debt in June 2020; about the same as the year before. However, it also had €1.62m in cash, and so its net debt is €49.9m.

A Look At Leptos Calypso Hotels's Liabilities

We can see from the most recent balance sheet that Leptos Calypso Hotels had liabilities of €10.4m falling due within a year, and liabilities of €69.8m due beyond that. On the other hand, it had cash of €1.62m and €1.56m worth of receivables due within a year. So it has liabilities totalling €76.9m more than its cash and near-term receivables, combined.

This deficit casts a shadow over the €8.32m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Leptos Calypso Hotels would probably need a major re-capitalization if its creditors were to demand repayment.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Leptos Calypso Hotels shareholders face the double whammy of a high net debt to EBITDA ratio (26.9), and fairly weak interest coverage, since EBIT is just 0.19 times the interest expense. This means we'd consider it to have a heavy debt load. Even worse, Leptos Calypso Hotels saw its EBIT tank 93% over the last 12 months. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. There's no doubt that we learn most about debt from the balance sheet. But it is Leptos Calypso Hotels'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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Leptos Calypso Hotels produced sturdy free cash flow equating to 70% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

On the face of it, Leptos Calypso Hotels's EBIT growth rate left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. After considering the datapoints discussed, we think Leptos Calypso Hotels has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. 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. For instance, we've identified 2 warning signs for Leptos Calypso Hotels that you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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