Is Hotel NewgrandLtd (TYO:9720) Using Debt Sensibly?

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 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 can see that Hotel Newgrand Co.,Ltd. (TYO:9720) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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

See our latest analysis for Hotel NewgrandLtd

How Much Debt Does Hotel NewgrandLtd Carry?

As you can see below, at the end of August 2020, Hotel NewgrandLtd had JP¥3.64b of debt, up from JP¥2.76b a year ago. Click the image for more detail. However, it does have JP¥419.0m in cash offsetting this, leading to net debt of about JP¥3.22b.

How Healthy Is Hotel NewgrandLtd's Balance Sheet?

We can see from the most recent balance sheet that Hotel NewgrandLtd had liabilities of JP¥2.66b falling due within a year, and liabilities of JP¥3.20b due beyond that. On the other hand, it had cash of JP¥419.0m and JP¥215.0m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by JP¥5.22b.

When you consider that this deficiency exceeds the company's JP¥3.89b market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Hotel NewgrandLtd will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, Hotel NewgrandLtd made a loss at the EBIT level, and saw its revenue drop to JP¥3.4b, which is a fall of 35%. That makes us nervous, to say the least.

Caveat Emptor

Not only did Hotel NewgrandLtd's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost a very considerable JP¥770m at the EBIT level. When we look at that alongside the significant liabilities, we're not particularly confident about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. Not least because it had negative free cash flow of JP¥397m over the last twelve months. That means it's on the risky side of things. 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. Consider for instance, the ever-present spectre of investment risk. We've identified 3 warning signs with Hotel NewgrandLtd (at least 2 which can't be ignored) , and understanding them should be part of your investment process.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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