Is Country Club Hospitality & Holidays (NSE:CCHHL) 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 note that Country Club Hospitality & Holidays Limited (NSE:CCHHL) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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 examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Country Club Hospitality & Holidays

How Much Debt Does Country Club Hospitality & Holidays Carry?

The image below, which you can click on for greater detail, shows that Country Club Hospitality & Holidays had debt of ₹468.3m at the end of September 2024, a reduction from ₹957.2m over a year. However, it does have ₹16.3m in cash offsetting this, leading to net debt of about ₹452.0m.

A Look At Country Club Hospitality & Holidays' Liabilities

The latest balance sheet data shows that Country Club Hospitality & Holidays had liabilities of ₹1.19b due within a year, and liabilities of ₹1.75b falling due after that. Offsetting these obligations, it had cash of ₹16.3m as well as receivables valued at ₹195.5m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹2.73b.

This is a mountain of leverage relative to its market capitalization of ₹3.40b. 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).

While we wouldn't worry about Country Club Hospitality & Holidays's net debt to EBITDA ratio of 3.1, we think its super-low interest cover of 0.91 times is a sign of high leverage. In large part that's due to the company's significant depreciation and amortisation charges, which arguably mean its EBITDA is a very generous measure of earnings, and its debt may be more of a burden than it first appears. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. Even worse, Country Club Hospitality & Holidays saw its EBIT tank 89% over the last 12 months. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Country Club Hospitality & Holidays 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's worth checking how much of that EBIT is backed by free cash flow. Over the last two years, Country Club Hospitality & Holidays 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

On the face of it, Country Club Hospitality & Holidays's conversion of EBIT to free cash flow left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. And furthermore, its level of total liabilities also fails to instill confidence. After considering the datapoints discussed, we think Country Club Hospitality & Holidays has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 3 warning signs for Country Club Hospitality & Holidays you should be aware of, and 1 of them makes us a bit uncomfortable.

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.

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.