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

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Associated International Hotels Limited (HKG:105) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out 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 March 2022, which is about the same as the year before. You can click the chart for greater detail. However, its balance sheet shows it holds HK$440.8m in cash, so it actually has HK$240.8m net cash.

How Strong Is Associated International Hotels' Balance Sheet?

We can see from the most recent balance sheet that Associated International Hotels had liabilities of HK$176.8m falling due within a year, and liabilities of HK$306.1m due beyond that. Offsetting this, it had HK$440.8m in cash and HK$153.9m in receivables that were due within 12 months. So it actually has HK$111.7m 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. Simply put, the fact that Associated International Hotels has more cash than debt is arguably a good indication that it can manage its debt safely.

It is just as well that Associated International Hotels's load is not too heavy, because its EBIT was down 43% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. 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.

Finally, while the tax-man may adore accounting profits, lenders only accept 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 67% 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$240.8m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of HK$187m, being 67% of its EBIT. So we are not troubled with Associated International Hotels's debt use. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example Associated International Hotels has 2 warning signs (and 1 which can't be ignored) we think you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.