Is Lealea Hotels & Resorts (GTSM:5364) Using Too Much Debt?

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 Lealea Hotels & Resorts Co., Ltd. (GTSM:5364) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Lealea Hotels & Resorts

How Much Debt Does Lealea Hotels & Resorts Carry?

As you can see below, Lealea Hotels & Resorts had NT$578.2m of debt, at September 2020, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has NT$135.5m in cash leading to net debt of about NT$442.7m.

How Strong Is Lealea Hotels & Resorts' Balance Sheet?

According to the last reported balance sheet, Lealea Hotels & Resorts had liabilities of NT$462.9m due within 12 months, and liabilities of NT$674.1m due beyond 12 months. Offsetting these obligations, it had cash of NT$135.5m as well as receivables valued at NT$23.0m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$978.4m.

The deficiency here weighs heavily on the NT$337.7m 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, Lealea Hotels & Resorts would probably need a major re-capitalization if its creditors were to demand repayment. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Lealea Hotels & Resorts 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 Lealea Hotels & Resorts had a loss before interest and tax, and actually shrunk its revenue by 12%, to NT$461m. That's not what we would hope to see.

Caveat Emptor

Not only did Lealea Hotels & Resorts's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). To be specific the EBIT loss came in at NT$5.1m. Combining this information with the significant liabilities we already touched on makes us very hesitant about this stock, to say the least. Of course, it may be able to improve its situation with a bit of luck and good execution. But we think that is unlikely since it is low on liquid assets, and made a loss of NT$31m in the last year. So we think this stock is quite risky. We'd prefer to pass. 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 Lealea Hotels & Resorts (of which 1 makes us a bit uncomfortable!) you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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