Tourism Holdings (NZSE:THL) Takes On Some Risk With Its Use Of Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Tourism Holdings Limited (NZSE:THL) makes use of debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Tourism Holdings

What Is Tourism Holdings's Net Debt?

The image below, which you can click on for greater detail, shows that Tourism Holdings had debt of NZ$80.6m at the end of December 2020, a reduction from NZ$191.9m over a year. However, because it has a cash reserve of NZ$51.3m, its net debt is less, at about NZ$29.3m.

How Healthy Is Tourism Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Tourism Holdings had liabilities of NZ$74.4m due within 12 months and liabilities of NZ$131.5m due beyond that. On the other hand, it had cash of NZ$51.3m and NZ$25.1m worth of receivables due within a year. So it has liabilities totalling NZ$129.5m more than its cash and near-term receivables, combined.

This deficit isn't so bad because Tourism Holdings is worth NZ$333.1m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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).

Tourism Holdings has a very low debt to EBITDA ratio of 0.50 so it is strange to see weak interest coverage, with last year's EBIT being only 1.1 times the interest expense. So one way or the other, it's clear the debt levels are not trivial. Importantly, Tourism Holdings's EBIT fell a jaw-dropping 78% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Tourism Holdings can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Tourism Holdings actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

Tourism Holdings's EBIT growth rate and interest cover definitely weigh on it, in our esteem. But its conversion of EBIT to free cash flow tells a very different story, and suggests some resilience. Looking at all the angles mentioned above, it does seem to us that Tourism Holdings is a somewhat risky investment as a result of its debt. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. 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. To that end, you should be aware of the 2 warning signs we've spotted with Tourism Holdings .

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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