We Think KHFM Hospitality and Facility Management Services (NSE:KHFM) Is Taking Some Risk With Its Debt

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 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?

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. If things get really bad, the lenders can take control of the business. 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. 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.

View our latest analysis for KHFM Hospitality and Facility Management Services

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

As you can see below, KHFM Hospitality and Facility Management Services had ₹420.6m of debt at September 2024, down from ₹438.6m a year prior. On the flip side, it has ₹116.0m in cash leading to net debt of about ₹304.6m.

A Look At KHFM Hospitality and Facility Management Services' Liabilities

According to the last reported balance sheet, KHFM Hospitality and Facility Management Services had liabilities of ₹528.5m due within 12 months, and liabilities of ₹69.9m due beyond 12 months. Offsetting these obligations, it had cash of ₹116.0m as well as receivables valued at ₹284.2m due within 12 months. So it has liabilities totalling ₹198.2m more than its cash and near-term receivables, combined.

Given KHFM Hospitality and Facility Management Services has a market capitalization of ₹2.04b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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 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 2.0 times is a sign of high leverage. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. Fortunately, KHFM Hospitality and Facility Management Services grew its EBIT by 7.5% in the last year, slowly shrinking its debt relative to earnings. 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, KHFM Hospitality and Facility Management Services saw substantial negative free cash flow, in total. 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. But its not so bad at growing its EBIT. 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. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 3 warning signs we've spotted with KHFM Hospitality and Facility Management Services (including 1 which is significant) .

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.