KHFM Hospitality and Facility Management Services (NSE:KHFM) Takes On Some Risk With Its Use Of Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

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

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

You can click the graphic below for the historical numbers, but it shows that KHFM Hospitality and Facility Management Services had ₹466.0m of debt in March 2023, down from ₹510.9m, one year before. However, it also had ₹294.2m in cash, and so its net debt is ₹171.8m.

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 ₹544.3m due within 12 months and liabilities of ₹118.6m due beyond that. On the other hand, it had cash of ₹294.2m and ₹192.0m worth of receivables due within a year. So it has liabilities totalling ₹176.8m more than its cash and near-term receivables, combined.

This deficit isn't so bad because KHFM Hospitality and Facility Management Services is worth ₹532.7m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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). 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 KHFM Hospitality and Facility Management Services has a quite reasonable net debt to EBITDA multiple of 2.0, its interest cover seems weak, at 1.4. This does have us wondering if the company pays high interest because it is considered risky. Either way there's no doubt the stock is using meaningful leverage. Notably, KHFM Hospitality and Facility Management Services made a loss at the EBIT level, last year, but improved that to positive EBIT of ₹83m in the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since KHFM Hospitality and Facility Management Services will need earnings to service that debt. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. During the last year, 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

To be frank both KHFM Hospitality and Facility Management Services's interest cover and its track record of converting EBIT to free cash flow make us rather uncomfortable with its debt levels. Having said that, its ability handle its debt, based on its EBITDA, isn't such a worry. 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 everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. 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. We've identified 2 warning signs with KHFM Hospitality and Facility Management Services , and understanding them should be part of your investment process.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.