Banyan Tree Holdings (SGX:B58) Use Of Debt Could Be Considered Risky

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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 note that Banyan Tree Holdings Limited (SGX:B58) 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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Banyan Tree Holdings

How Much Debt Does Banyan Tree Holdings Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2020 Banyan Tree Holdings had S$516.8m of debt, an increase on S$459.8m, over one year. However, it does have S$53.2m in cash offsetting this, leading to net debt of about S$463.6m.

How Healthy Is Banyan Tree Holdings's Balance Sheet?

According to the last reported balance sheet, Banyan Tree Holdings had liabilities of S$458.2m due within 12 months, and liabilities of S$486.5m due beyond 12 months. Offsetting these obligations, it had cash of S$53.2m as well as receivables valued at S$86.6m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by S$804.8m.

The deficiency here weighs heavily on the S$201.6m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Banyan Tree Holdings would probably need a major re-capitalization if its creditors were to demand repayment.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Banyan Tree Holdings shareholders face the double whammy of a high net debt to EBITDA ratio (18.5), and fairly weak interest coverage, since EBIT is just 0.25 times the interest expense. The debt burden here is substantial. Worse, Banyan Tree Holdings's EBIT was down 62% over the last year. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. There's no doubt that we learn most about debt from the balance sheet. But it is Banyan Tree Holdings's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Banyan Tree Holdings saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

On the face of it, Banyan Tree Holdings's EBIT growth rate left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. And furthermore, its interest cover also fails to instill confidence. It looks to us like Banyan Tree Holdings carries a significant balance sheet burden. If you play with fire you risk getting burnt, so we'd probably give this stock a wide berth. Given the risks around Banyan Tree Holdings's use of debt, the sensible thing to do is to check if insiders have been unloading the stock.

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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