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. We can see that Regal Hotels International Holdings Limited (HKG:78) does use debt in its business. But the real question is whether this debt is making the company risky.
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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.
How Much Debt Does Regal Hotels International Holdings Carry?
As you can see below, Regal Hotels International Holdings had HK$16.0b of debt, at December 2020, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has HK$4.21b in cash leading to net debt of about HK$11.8b.
A Look At Regal Hotels International Holdings' Liabilities
The latest balance sheet data shows that Regal Hotels International Holdings had liabilities of HK$10.5b due within a year, and liabilities of HK$6.80b falling due after that. Offsetting these obligations, it had cash of HK$4.21b as well as receivables valued at HK$825.7m due within 12 months. So it has liabilities totalling HK$12.3b more than its cash and near-term receivables, combined.
The deficiency here weighs heavily on the HK$2.67b 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'd watch its balance sheet closely, without a doubt. At the end of the day, Regal Hotels International Holdings would probably need a major re-capitalization if its creditors were to demand repayment. There's no doubt that we learn most about debt from the balance sheet. But it is Regal Hotels International Holdings'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.
Given it has no significant operating revenue at the moment, shareholders will be hoping Regal Hotels International Holdings can make progress and gain better traction for the business, before it runs low on cash.
Not only did Regal Hotels International Holdings's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Its EBIT loss was a whopping HK$354m. Combining this information with the significant liabilities we already touched on makes us very hesitant about this stock, to say the least. That said, it is possible that the company will turn its fortunes around. Nevertheless, we would not bet on it given that it lost HK$886m in just last twelve months, and it doesn't have much by way of liquid assets. So we think this stock is quite risky. We'd prefer to pass. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 2 warning signs for Regal Hotels International Holdings that you should be aware of before investing here.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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