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.' 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. We can see that Hotel Properties Limited (SGX:H15) does use debt in its business. 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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does Hotel Properties Carry?
As you can see below, at the end of December 2020, Hotel Properties had S$1.01b of debt, up from S$856.6m a year ago. Click the image for more detail. On the flip side, it has S$112.9m in cash leading to net debt of about S$901.0m.
How Healthy Is Hotel Properties' Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Hotel Properties had liabilities of S$267.9m due within 12 months and liabilities of S$972.5m due beyond that. Offsetting this, it had S$112.9m in cash and S$159.3m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by S$968.2m.
While this might seem like a lot, it is not so bad since Hotel Properties has a market capitalization of S$1.82b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. When analysing debt levels, the balance sheet is the obvious place to start. But it is Hotel Properties'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.
In the last year Hotel Properties had a loss before interest and tax, and actually shrunk its revenue by 53%, to S$259m. To be frank that doesn't bode well.
While Hotel Properties's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. To be specific the EBIT loss came in at S$64m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. However, it doesn't help that it burned through S$61m of cash over the last year. 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. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Hotel Properties you should know about.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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