Here's Why KHFM Hospitality and Facility Management Services (NSE:KHFM) Has A Meaningful Debt Burden

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. Importantly, KHFM Hospitality and Facility Management Services Limited (NSE:KHFM) does carry debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for KHFM Hospitality and Facility Management Services

What Is KHFM Hospitality and Facility Management Services's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2021 KHFM Hospitality and Facility Management Services had ₹398.2m of debt, an increase on ₹277.2m, over one year. However, because it has a cash reserve of ₹84.6m, its net debt is less, at about ₹313.6m.

How Strong Is KHFM Hospitality and Facility Management Services' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that KHFM Hospitality and Facility Management Services had liabilities of ₹559.6m due within 12 months and liabilities of ₹110.8m due beyond that. Offsetting these obligations, it had cash of ₹84.6m as well as receivables valued at ₹129.3m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹456.5m.

This is a mountain of leverage relative to its market capitalization of ₹544.2m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Weak interest cover of 0.75 times and a disturbingly high net debt to EBITDA ratio of 6.1 hit our confidence in KHFM Hospitality and Facility Management Services like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. One redeeming factor for KHFM Hospitality and Facility Management Services is that it turned last year's EBIT loss into a gain of ₹48m, over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is KHFM Hospitality and Facility Management Services'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. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, KHFM Hospitality and Facility Management Services actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

Neither KHFM Hospitality and Facility Management Services's ability to cover its interest expense with its EBIT nor its net debt to EBITDA 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. When we consider all the factors discussed, it seems to us that KHFM Hospitality and Facility Management Services is taking some risks with its use of debt. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 3 warning signs for KHFM Hospitality and Facility Management Services you should be aware of.

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.