Stock Analysis

Auditors Have Doubts About EIH (NSE:EIHOTEL)

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The harsh reality for EIH Limited (NSE:EIHOTEL) shareholders is that its auditors, Deloitte Haskins & Sells, expressed doubts about its ability to continue as a going concern, in its reported results to March 2020. It is therefore fair to assume that, based on those financials, the company should strengthen its balance sheet in the short term, perhaps by issuing shares.

Given its situation, it may not be in a good position to raise capital on favorable terms. So it is suddenly extremely important to consider whether the company is taking too much risk on its balance sheet. The biggest concern we would have is the company's debt, since its lenders might force the company into administration if it cannot repay them.

See our latest analysis for EIH

What Is EIH's Debt?

You can click the graphic below for the historical numbers, but it shows that EIH had ₹4.76b of debt in March 2020, down from ₹5.41b, one year before. However, because it has a cash reserve of ₹1.77b, its net debt is less, at about ₹2.99b.

NSEI:EIHOTEL Debt to Equity History July 25th 2020

How Healthy Is EIH's Balance Sheet?

According to the last reported balance sheet, EIH had liabilities of ₹6.01b due within 12 months, and liabilities of ₹6.15b due beyond 12 months. Offsetting this, it had ₹1.77b in cash and ₹2.10b in receivables that were due within 12 months. So it has liabilities totalling ₹8.3b more than its cash and near-term receivables, combined.

This deficit isn't so bad because EIH is worth ₹35.8b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

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).

EIH has a low net debt to EBITDA ratio of only 1.0. And its EBIT easily covers its interest expense, being 16.4 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. The modesty of its debt load may become crucial for EIH if management cannot prevent a repeat of the 41% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But it is EIH's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, EIH's free cash flow amounted to 34% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

EIH's EBIT growth rate and conversion of EBIT to free cash flow definitely weigh on it, in our esteem. But its interest cover tells a very different story, and suggests some resilience. We think that EIH's debt does make it a bit risky, after considering the aforementioned data points together. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. Some investors may be interested in buying high risk stocks at the right price, but we prefer to avoid a company after its auditor has expressed any uncertainty about its ability to continue as a going concern. Our preference is to invest in companies that always make sure the auditor has confidence that the company will continue as a going concern. 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. For example, we've discovered 2 warning signs for EIH (1 is significant!) that you should be aware of before investing here.

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.

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This article by Simply Wall St is general in nature. 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.
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