KHFM Hospitality and Facility Management Services (NSE:KHFM) Has A Somewhat Strained Balance Sheet

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 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 is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for KHFM Hospitality and Facility Management Services

How Much Debt Does KHFM Hospitality and Facility Management Services Carry?

As you can see below, at the end of September 2022, KHFM Hospitality and Facility Management Services had ₹463.2m of debt, up from ₹398.2m a year ago. Click the image for more detail. On the flip side, it has ₹99.4m in cash leading to net debt of about ₹363.8m.

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

We can see from the most recent balance sheet that KHFM Hospitality and Facility Management Services had liabilities of ₹520.4m falling due within a year, and liabilities of ₹133.8m due beyond that. Offsetting this, it had ₹99.4m in cash and ₹147.0m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹407.8m.

This is a mountain of leverage relative to its market capitalization of ₹546.2m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

KHFM Hospitality and Facility Management Services shareholders face the double whammy of a high net debt to EBITDA ratio (29.9), and fairly weak interest coverage, since EBIT is just 0.17 times the interest expense. This means we'd consider it to have a heavy debt load. Worse, KHFM Hospitality and Facility Management Services's EBIT was down 84% over the last year. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. There's no doubt that we learn most about debt from the balance sheet. 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Happily for any shareholders, KHFM Hospitality and Facility Management Services actually produced more free cash flow than EBIT over the last two years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

To be frank both KHFM Hospitality and Facility Management Services's interest cover and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. But on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. Overall, we think it's fair to say that KHFM Hospitality and Facility Management Services has enough debt that there are some real risks around the balance sheet. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the 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. Be aware that KHFM Hospitality and Facility Management Services is showing 2 warning signs in our investment analysis , 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.

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.