Hotel Grand Central (SGX:H18) Seems To Use Debt Quite Sensibly

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. As with many other companies Hotel Grand Central Limited (SGX:H18) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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 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, 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 think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Hotel Grand Central

How Much Debt Does Hotel Grand Central Carry?

You can click the graphic below for the historical numbers, but it shows that Hotel Grand Central had S$50.4m of debt in June 2020, down from S$55.6m, one year before. However, it does have S$209.7m in cash offsetting this, leading to net cash of S$159.4m.

How Strong Is Hotel Grand Central's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Hotel Grand Central had liabilities of S$46.2m due within 12 months and liabilities of S$177.4m due beyond that. Offsetting these obligations, it had cash of S$209.7m as well as receivables valued at S$7.88m due within 12 months. So it has liabilities totalling S$5.98m more than its cash and near-term receivables, combined.

Having regard to Hotel Grand Central's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the S$741.1m company is struggling for cash, we still think it's worth monitoring its balance sheet. Despite its noteworthy liabilities, Hotel Grand Central boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that Hotel Grand Central's load is not too heavy, because its EBIT was down 25% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But it is Hotel Grand Central'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Hotel Grand Central 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. During the last three years, Hotel Grand Central produced sturdy free cash flow equating to 77% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Hotel Grand Central has S$159.4m in net cash. And it impressed us with free cash flow of S$19m, being 77% of its EBIT. So we don't have any problem with Hotel Grand Central's use of debt. 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. For instance, we've identified 3 warning signs for Hotel Grand Central (1 is potentially serious) you should be aware of.

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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