Is Hotel Holiday Garden (TPE:2702) Using Debt Sensibly?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. We can see that Hotel Holiday Garden (TPE:2702) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Hotel Holiday Garden

What Is Hotel Holiday Garden's Debt?

As you can see below, Hotel Holiday Garden had NT$5.54b of debt at September 2020, down from NT$5.81b a year prior. However, because it has a cash reserve of NT$973.1m, its net debt is less, at about NT$4.57b.

How Healthy Is Hotel Holiday Garden's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Hotel Holiday Garden had liabilities of NT$2.57b due within 12 months and liabilities of NT$3.69b due beyond that. Offsetting these obligations, it had cash of NT$973.1m as well as receivables valued at NT$65.3m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$5.22b.

This deficit casts a shadow over the NT$1.91b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Hotel Holiday Garden would likely require a major re-capitalisation if it had to pay its creditors today. When analysing debt levels, the balance sheet is the obvious place to start. But it is Hotel Holiday Garden'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.

In the last year Hotel Holiday Garden had a loss before interest and tax, and actually shrunk its revenue by 31%, to NT$972m. To be frank that doesn't bode well.

Caveat Emptor

Not only did Hotel Holiday Garden's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost NT$73m at the EBIT level. 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 vaporized NT$227m in cash over the last twelve months, and it doesn't have much by way of liquid assets. So we consider this a high risk stock and we wouldn't be at all surprised if the company asks shareholders for money before long. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 3 warning signs we've spotted with Hotel Holiday Garden (including 2 which is are potentially serious) .

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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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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