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. As with many other companies Hotel Orchard Park CO., LTD. (GTSM:2750) makes use of debt. But is this debt a concern to shareholders?
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does Hotel Orchard Park Carry?
As you can see below, Hotel Orchard Park had NT$863.8m of debt at December 2020, down from NT$961.6m a year prior. However, it does have NT$56.8m in cash offsetting this, leading to net debt of about NT$807.0m.
How Strong Is Hotel Orchard Park's Balance Sheet?
We can see from the most recent balance sheet that Hotel Orchard Park had liabilities of NT$393.5m falling due within a year, and liabilities of NT$1.41b due beyond that. Offsetting these obligations, it had cash of NT$56.8m as well as receivables valued at NT$13.6m due within 12 months. So it has liabilities totalling NT$1.73b more than its cash and near-term receivables, combined.
This deficit casts a shadow over the NT$508.4m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Hotel Orchard Park would probably need a major re-capitalization if its creditors were to demand repayment. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Hotel Orchard Park will need earnings to service that debt. 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.
In the last year Hotel Orchard Park had a loss before interest and tax, and actually shrunk its revenue by 14%, to NT$334m. We would much prefer see growth.
While Hotel Orchard Park'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 NT$25m. If you consider the significant liabilities mentioned above, we are extremely wary of this investment. That said, it is possible that the company will turn its fortunes around. Nevertheless, we would not bet on it given that it lost NT$18m in just last twelve months, and it doesn't have much by way of liquid assets. So we think this stock is quite risky. We'd prefer to pass. 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. Case in point: We've spotted 2 warning signs for Hotel Orchard Park you should be aware of, and 1 of them doesn't sit too well with us.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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