Is KHFM Hospitality and Facility Management Services (NSE:KHFM) Using Too Much Debt?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 KHFM Hospitality and Facility Management Services Limited (NSE:KHFM) does use debt in its business. But the real question is whether this debt is making the company risky.

This technology could replace computers: discover the 20 stocks are working to make quantum computing a reality.

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

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

The image below, which you can click on for greater detail, shows that KHFM Hospitality and Facility Management Services had debt of ₹420.6m at the end of September 2024, a reduction from ₹438.6m over a year. However, it also had ₹116.0m in cash, and so its net debt is ₹304.6m.

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

The latest balance sheet data shows that KHFM Hospitality and Facility Management Services had liabilities of ₹528.5m due within a year, and liabilities of ₹69.9m falling due after that. Offsetting these obligations, it had cash of ₹116.0m as well as receivables valued at ₹284.2m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹198.2m.

Of course, KHFM Hospitality and Facility Management Services has a market capitalization of ₹1.75b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

Check out our latest analysis for KHFM Hospitality and Facility Management Services

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).

While we wouldn't worry about KHFM Hospitality and Facility Management Services's net debt to EBITDA ratio of 2.9, we think its super-low interest cover of 1.9 times is a sign of high leverage. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. The good news is that KHFM Hospitality and Facility Management Services improved its EBIT by 6.2% over the last twelve months, thus gradually reducing its debt levels relative to its earnings. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since KHFM Hospitality and Facility Management Services 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. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, KHFM Hospitality and Facility Management Services burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

While KHFM Hospitality and Facility Management Services's interest cover makes us cautious about it, its track record of converting EBIT to free cash flow is no better. At least its EBIT growth rate gives us reason to be optimistic. Taking the abovementioned factors together we do think KHFM Hospitality and Facility Management Services's debt poses some risks to the business. 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. For instance, we've identified 4 warning signs for KHFM Hospitality and Facility Management Services (2 are potentially serious) you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.