Does Hongkong and Shanghai Hotels (HKG:45) Have A Healthy Balance Sheet?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. Importantly, The Hongkong and Shanghai Hotels, Limited (HKG:45) does carry debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Hongkong and Shanghai Hotels

What Is Hongkong and Shanghai Hotels's Net Debt?

The image below, which you can click on for greater detail, shows that at December 2020 Hongkong and Shanghai Hotels had debt of HK$11.2b, up from HK$7.55b in one year. However, it also had HK$520.0m in cash, and so its net debt is HK$10.7b.

How Healthy Is Hongkong and Shanghai Hotels' Balance Sheet?

The latest balance sheet data shows that Hongkong and Shanghai Hotels had liabilities of HK$3.37b due within a year, and liabilities of HK$13.2b falling due after that. Offsetting these obligations, it had cash of HK$520.0m as well as receivables valued at HK$303.0m due within 12 months. So its liabilities total HK$15.7b more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of HK$14.0b, we think shareholders really should watch Hongkong and Shanghai Hotels's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Hongkong and Shanghai Hotels 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.

Over 12 months, Hongkong and Shanghai Hotels made a loss at the EBIT level, and saw its revenue drop to HK$2.7b, which is a fall of 54%. That makes us nervous, to say the least.

Caveat Emptor

Not only did Hongkong and Shanghai Hotels'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 HK$614m. When we look at that alongside the significant liabilities, we're not particularly confident about the company. It would need to improve its operations quickly for us to be interested in it. Not least because it burned through HK$1.3b in negative free cash flow over the last year. That means it's on the risky side of things. For riskier companies like Hongkong and Shanghai Hotels I always like to keep an eye on the long term profit and revenue trends. Fortunately, you can click to see our interactive graph of its profit, revenue, and operating cashflow.

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. 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.
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