Is Dalata Hotel Group (ISE:DHG) A Risky Investment?

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 note that Dalata Hotel Group plc (ISE:DHG) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. When we think about a company's use of debt, we first look at cash and debt together.

What Is Dalata Hotel Group's Net Debt?

The image below, which you can click on for greater detail, shows that at December 2024 Dalata Hotel Group had debt of €271.6m, up from €254.4m in one year. However, it does have €39.6m in cash offsetting this, leading to net debt of about €232.1m.

How Strong Is Dalata Hotel Group's Balance Sheet?

The latest balance sheet data shows that Dalata Hotel Group had liabilities of €106.5m due within a year, and liabilities of €1.13b falling due after that. Offsetting these obligations, it had cash of €39.6m as well as receivables valued at €18.4m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €1.18b.

This deficit is considerable relative to its market capitalization of €1.18b, so it does suggest shareholders should keep an eye on Dalata Hotel Group's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

View our latest analysis for Dalata Hotel Group

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

While Dalata Hotel Group's low debt to EBITDA ratio of 1.2 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 2.7 times last year does give us pause. So we'd recommend keeping a close eye on the impact financing costs are having on the business. Importantly Dalata Hotel Group's EBIT was essentially flat over the last twelve months. Ideally it can diminish its debt load by kick-starting earnings growth. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Dalata Hotel Group's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Dalata Hotel Group recorded free cash flow worth a fulsome 85% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Our View

Neither Dalata Hotel Group's ability to cover its interest expense with its EBIT nor its level of total liabilities gave us confidence in its ability to take on more debt. But its conversion of EBIT to free cash flow tells a very different story, and suggests some resilience. We think that Dalata Hotel Group's debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. We've identified 1 warning sign with Dalata Hotel Group , and understanding them should be part of your investment process.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.