Here's Why Associated International Hotels (HKG:105) Can Manage Its Debt Responsibly

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. We can see that Associated International Hotels Limited (HKG:105) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Associated International Hotels

How Much Debt Does Associated International Hotels Carry?

As you can see below, Associated International Hotels had HK$200.0m of debt, at September 2020, which is about the same as the year before. You can click the chart for greater detail. However, it does have HK$510.2m in cash offsetting this, leading to net cash of HK$310.2m.

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$310.0m falling due within a year, and liabilities of HK$293.6m due beyond that. On the other hand, it had cash of HK$510.2m and HK$156.4m worth of receivables due within a year. So it can boast HK$63.0m more liquid assets than total liabilities.

This state of affairs indicates that Associated International Hotels' balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the HK$4.79b company is struggling for cash, we still think it's worth monitoring its balance sheet. Succinctly put, Associated International Hotels boasts net cash, so it's fair to say it does not have a heavy debt load!

On the other hand, Associated International Hotels's EBIT dived 17%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Associated International Hotels 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.

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. During the last three years, Associated International Hotels produced sturdy free cash flow equating to 73% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While it is always sensible to investigate a company's debt, in this case Associated International Hotels has HK$310.2m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 73% of that EBIT to free cash flow, bringing in HK$189m. 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. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for Associated International Hotels you should be aware of, and 1 of them shouldn't be ignored.

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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