Here's Why EIH (NSE:EIHOTEL) Can Afford Some 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 EIH Limited (NSE:EIHOTEL) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt A Problem?

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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

View our latest analysis for EIH

What Is EIH's Net Debt?

The image below, which you can click on for greater detail, shows that EIH had debt of ₹2.77b at the end of March 2021, a reduction from ₹4.76b over a year. However, because it has a cash reserve of ₹2.70b, its net debt is less, at about ₹69.3m.

A Look At EIH's Liabilities

Zooming in on the latest balance sheet data, we can see that EIH had liabilities of ₹4.09b due within 12 months and liabilities of ₹5.25b due beyond that. Offsetting these obligations, it had cash of ₹2.70b as well as receivables valued at ₹777.5m due within 12 months. So it has liabilities totalling ₹5.86b more than its cash and near-term receivables, combined.

Of course, EIH has a market capitalization of ₹56.3b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Carrying virtually no net debt, EIH has a very light debt load indeed. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine EIH's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Over 12 months, EIH made a loss at the EBIT level, and saw its revenue drop to ₹5.5b, which is a fall of 66%. That makes us nervous, to say the least.

Caveat Emptor

While EIH's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost ₹3.7b at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled ₹2.1b in negative free cash flow over the last twelve months. So suffice it to say we do consider the stock to be risky. 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. For instance, we've identified 2 warning signs for EIH (1 is a bit concerning) you should be aware of.

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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