Here's Why Pleasant Hotels International (GTSM:2718) Has A Meaningful Debt Burden

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.' 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 note that Pleasant Hotels International Inc. (GTSM:2718) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Pleasant Hotels International

What Is Pleasant Hotels International's Net Debt?

As you can see below, at the end of September 2020, Pleasant Hotels International had NT$893.0m of debt, up from NT$766.5m a year ago. Click the image for more detail. However, it does have NT$249.6m in cash offsetting this, leading to net debt of about NT$643.3m.

How Strong Is Pleasant Hotels International's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Pleasant Hotels International had liabilities of NT$959.3m due within 12 months and liabilities of NT$115.6m due beyond that. Offsetting these obligations, it had cash of NT$249.6m as well as receivables valued at NT$600.0k due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$824.6m.

This deficit is considerable relative to its market capitalization of NT$923.9m, so it does suggest shareholders should keep an eye on Pleasant Hotels International's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Strangely Pleasant Hotels International has a sky high EBITDA ratio of 46.0, implying high debt, but a strong interest coverage of 1k. This means that unless the company has access to very cheap debt, that interest expense will likely grow in the future. We also note that Pleasant Hotels International improved its EBIT from a last year's loss to a positive NT$206k. When analysing debt levels, the balance sheet is the obvious place to start. But it is Pleasant Hotels International'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 company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, Pleasant Hotels International saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

To be frank both Pleasant Hotels International's net debt to EBITDA and its track record of converting EBIT to free cash flow make us rather uncomfortable with its debt levels. But on the bright side, its interest cover is a good sign, and makes us more optimistic. Overall, we think it's fair to say that Pleasant Hotels International has enough debt that there are some real risks around the balance sheet. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Like risks, for instance. Every company has them, and we've spotted 3 warning signs for Pleasant Hotels International (of which 2 are potentially serious!) you should know about.

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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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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