Here's Why 1957 (Hospitality) (HKG:8495) Can Manage Its Debt Responsibly

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.' 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. We note that 1957 & Co. (Hospitality) Limited (HKG:8495) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for 1957 (Hospitality)

What Is 1957 (Hospitality)'s Debt?

As you can see below, 1957 (Hospitality) had HK$16.3m of debt at June 2021, down from HK$20.2m a year prior. However, its balance sheet shows it holds HK$79.5m in cash, so it actually has HK$63.3m net cash.

A Look At 1957 (Hospitality)'s Liabilities

The latest balance sheet data shows that 1957 (Hospitality) had liabilities of HK$113.9m due within a year, and liabilities of HK$31.3m falling due after that. On the other hand, it had cash of HK$79.5m and HK$8.46m worth of receivables due within a year. So its liabilities total HK$57.2m more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of HK$75.6m, so it does suggest shareholders should keep an eye on 1957 (Hospitality)'s use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. While it does have liabilities worth noting, 1957 (Hospitality) also has more cash than debt, so we're pretty confident it can manage its debt safely.

We also note that 1957 (Hospitality) improved its EBIT from a last year's loss to a positive HK$6.9m. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since 1957 (Hospitality) will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While 1957 (Hospitality) has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last year, 1957 (Hospitality) actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

Although 1957 (Hospitality)'s balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of HK$63.3m. The cherry on top was that in converted 1,326% of that EBIT to free cash flow, bringing in HK$92m. So we don't have any problem with 1957 (Hospitality)'s use of debt. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Be aware that 1957 (Hospitality) is showing 2 warning signs in our investment analysis , and 1 of those is potentially serious...

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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