Here's Why PPHE Hotel Group (LON:PPH) Is Weighed Down By Its Debt Load

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. As with many other companies PPHE Hotel Group Limited (LON:PPH) makes use of debt. But should shareholders be worried about its use of debt?

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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 examine debt levels, we first consider both cash and debt levels, together.

What Is PPHE Hotel Group's Debt?

As you can see below, PPHE Hotel Group had UK£885.6m of debt, at December 2024, which is about the same as the year before. You can click the chart for greater detail. However, it also had UK£113.2m in cash, and so its net debt is UK£772.4m.

How Strong Is PPHE Hotel Group's Balance Sheet?

The latest balance sheet data shows that PPHE Hotel Group had liabilities of UK£167.4m due within a year, and liabilities of UK£1.20b falling due after that. Offsetting this, it had UK£113.2m in cash and UK£25.1m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by UK£1.23b.

This deficit casts a shadow over the UK£522.2m 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, PPHE Hotel Group would probably need a major re-capitalization if its creditors were to demand repayment.

See our latest analysis for PPHE Hotel Group

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.

PPHE Hotel Group has a rather high debt to EBITDA ratio of 6.0 which suggests a meaningful debt load. However, its interest coverage of 2.9 is reasonably strong, which is a good sign. Fortunately, PPHE Hotel Group grew its EBIT by 7.5% in the last year, slowly shrinking its debt relative to earnings. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if PPHE 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, PPHE Hotel Group saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

On the face of it, PPHE Hotel Group's conversion of EBIT to free cash flow 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 EBIT growth rate is a good sign, and makes us more optimistic. Taking into account all the aforementioned factors, it looks like PPHE Hotel Group has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 3 warning signs we've spotted with PPHE Hotel Group (including 1 which can't be ignored) .

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.