Is NH Hotel Group (BME:NHH) A Risky Investment?

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies NH Hotel Group, S.A. (BME:NHH) 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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

Check out the opportunities and risks within the XX Hospitality industry.

What Is NH Hotel Group's Net Debt?

You can click the graphic below for the historical numbers, but it shows that NH Hotel Group had €815.8m of debt in June 2022, down from €1.14b, one year before. However, it also had €351.2m in cash, and so its net debt is €464.6m.

How Healthy Is NH Hotel Group's Balance Sheet?

According to the last reported balance sheet, NH Hotel Group had liabilities of €723.9m due within 12 months, and liabilities of €2.68b due beyond 12 months. Offsetting this, it had €351.2m in cash and €169.4m in receivables that were due within 12 months. So it has liabilities totalling €2.89b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the €1.18b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, NH Hotel Group would likely require a major re-capitalisation if it had to pay its creditors today.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

While NH Hotel Group has a quite reasonable net debt to EBITDA multiple of 1.9, its interest cover seems weak, at 1.1. This does suggest the company is paying fairly high interest rates. Either way there's no doubt the stock is using meaningful leverage. We also note that NH Hotel Group improved its EBIT from a last year's loss to a positive €151m. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if NH Hotel Group can strengthen its balance sheet over time. 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 it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, NH Hotel Group actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

To be frank both NH Hotel Group's interest cover and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. Once we consider all the factors above, together, it seems to us that NH Hotel Group's debt is making it a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - NH Hotel Group has 1 warning sign we think you should be aware of.

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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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.