EIH (NSE:EIHOTEL) Seems To Use Debt Rather Sparingly

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that EIH Limited (NSE:EIHOTEL) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest 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 EIH

What Is EIH's Net Debt?

The chart below, which you can click on for greater detail, shows that EIH had ₹2.00b in debt in September 2024; about the same as the year before. However, its balance sheet shows it holds ₹7.71b in cash, so it actually has ₹5.71b net cash.

How Healthy Is EIH's Balance Sheet?

The latest balance sheet data shows that EIH had liabilities of ₹5.98b due within a year, and liabilities of ₹4.32b falling due after that. Offsetting this, it had ₹7.71b in cash and ₹1.84b in receivables that were due within 12 months. So its liabilities total ₹752.5m more than the combination of its cash and short-term receivables.

This state of affairs indicates that EIH's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the ₹208.9b company is struggling for cash, we still think it's worth monitoring its balance sheet. While it does have liabilities worth noting, EIH also has more cash than debt, so we're pretty confident it can manage its debt safely.

Also good is that EIH grew its EBIT at 17% over the last year, further increasing its ability to manage debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if EIH can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While EIH has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, EIH produced sturdy free cash flow equating to 60% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that EIH has ₹5.71b in net cash. And it impressed us with its EBIT growth of 17% over the last year. So we don't think EIH's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that EIH is showing 1 warning sign 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.

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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.