Here's Why Millennium & Copthorne Hotels New Zealand (NZSE:MCK) Can Manage Its Debt Responsibly

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 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. Importantly, Millennium & Copthorne Hotels New Zealand Limited (NZSE:MCK) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Millennium & Copthorne Hotels New Zealand

What Is Millennium & Copthorne Hotels New Zealand's Net Debt?

The image below, which you can click on for greater detail, shows that Millennium & Copthorne Hotels New Zealand had debt of NZ$67.3m at the end of June 2020, a reduction from NZ$76.0m over a year. However, it does have NZ$182.3m in cash offsetting this, leading to net cash of NZ$115.0m.

How Strong Is Millennium & Copthorne Hotels New Zealand's Balance Sheet?

According to the last reported balance sheet, Millennium & Copthorne Hotels New Zealand had liabilities of NZ$26.2m due within 12 months, and liabilities of NZ$131.8m due beyond 12 months. Offsetting this, it had NZ$182.3m in cash and NZ$13.5m in receivables that were due within 12 months. So it actually has NZ$37.8m more liquid assets than total liabilities.

This short term liquidity is a sign that Millennium & Copthorne Hotels New Zealand could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Millennium & Copthorne Hotels New Zealand has more cash than debt is arguably a good indication that it can manage its debt safely.

While Millennium & Copthorne Hotels New Zealand doesn't seem to have gained much on the EBIT line, at least earnings remain stable for now. When analysing debt levels, the balance sheet is the obvious place to start. But it is Millennium & Copthorne Hotels New Zealand's earnings that will influence how the balance sheet holds up in the future. 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. Millennium & Copthorne Hotels New Zealand may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. In the last three years, Millennium & Copthorne Hotels New Zealand's free cash flow amounted to 48% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While it is always sensible to investigate a company's debt, in this case Millennium & Copthorne Hotels New Zealand has NZ$115.0m in net cash and a decent-looking balance sheet. So we are not troubled with Millennium & Copthorne Hotels New Zealand's debt use. Given Millennium & Copthorne Hotels New Zealand has a strong balance sheet is profitable and pays a dividend, it would be good to know how fast its dividends are growing, if at all. You can find out instantly by clicking this link.

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. 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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