Associated International Hotels (HKG:105) Has A Pretty Healthy Balance Sheet

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. Importantly, Associated International Hotels Limited (HKG:105) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Associated International Hotels

What Is Associated International Hotels's Debt?

As you can see below, Associated International Hotels had HK$200.0m of debt, at September 2021, which is about the same as the year before. You can click the chart for greater detail. But it also has HK$500.3m in cash to offset that, meaning it has HK$300.3m net cash.

How Strong Is Associated International Hotels' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Associated International Hotels had liabilities of HK$249.6m due within 12 months and liabilities of HK$301.8m due beyond that. On the other hand, it had cash of HK$500.3m and HK$156.3m worth of receivables due within a year. So it can boast HK$105.2m more liquid assets than total liabilities.

This surplus suggests that Associated International Hotels has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Associated International Hotels boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact Associated International Hotels's saving grace is its low debt levels, because its EBIT has tanked 41% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Associated International Hotels'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Associated International Hotels may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the most recent three years, Associated International Hotels recorded free cash flow worth 65% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While it is always sensible to investigate a company's debt, in this case Associated International Hotels has HK$300.3m in net cash and a decent-looking balance sheet. So we don't have any problem with Associated International Hotels's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 2 warning signs with Associated International Hotels (at least 1 which makes us a bit uncomfortable) , and understanding them should be part of your investment process.

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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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.