Magnificent Hotel Investments (HKG:201) Is Making Moderate Use Of 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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Magnificent Hotel Investments Limited (HKG:201) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Magnificent Hotel Investments

How Much Debt Does Magnificent Hotel Investments Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2020 Magnificent Hotel Investments had HK$771.9m of debt, an increase on HK$399.1m, over one year. However, it does have HK$390.7m in cash offsetting this, leading to net debt of about HK$381.2m.

How Healthy Is Magnificent Hotel Investments's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Magnificent Hotel Investments had liabilities of HK$585.1m due within 12 months and liabilities of HK$328.9m due beyond that. Offsetting these obligations, it had cash of HK$390.7m as well as receivables valued at HK$12.0m due within 12 months. So its liabilities total HK$511.4m more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of HK$850.0m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Magnificent Hotel Investments's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

In the last year Magnificent Hotel Investments had a loss before interest and tax, and actually shrunk its revenue by 57%, to HK$249m. That makes us nervous, to say the least.

Caveat Emptor

While Magnificent Hotel Investments's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. To be specific the EBIT loss came in at HK$69m. 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. However, it doesn't help that it burned through HK$33m of cash over the last year. So to be blunt we think it is risky. 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. Consider risks, for instance. Every company has them, and we've spotted 1 warning sign for Magnificent Hotel Investments you should know about.

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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