Is Wanda Hotel Development (HKG:169) A Risky Investment?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Wanda Hotel Development Company Limited (HKG:169) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

Our analysis indicates that 169 is potentially undervalued!

What Is Wanda Hotel Development's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Wanda Hotel Development had HK$51.7m of debt in June 2022, down from HK$873.0m, one year before. However, its balance sheet shows it holds HK$1.12b in cash, so it actually has HK$1.07b net cash.

How Healthy Is Wanda Hotel Development's Balance Sheet?

The latest balance sheet data shows that Wanda Hotel Development had liabilities of HK$1.47b due within a year, and liabilities of HK$634.5m falling due after that. Offsetting these obligations, it had cash of HK$1.12b as well as receivables valued at HK$303.3m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$677.7m.

This is a mountain of leverage relative to its market capitalization of HK$840.8m. 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, Wanda Hotel Development also has more cash than debt, so we're pretty confident it can manage its debt safely.

The modesty of its debt load may become crucial for Wanda Hotel Development if management cannot prevent a repeat of the 30% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But it is Wanda Hotel Development's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Wanda Hotel Development 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 three years, Wanda Hotel Development saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

Although Wanda Hotel Development'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$1.07b. Despite its cash we think that Wanda Hotel Development seems to struggle to grow its EBIT, so we are wary of the stock. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Wanda Hotel Development 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.