Stock Analysis

Is H World Group (NASDAQ:HTHT) A Risky Investment?

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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 H World Group Limited (NASDAQ:HTHT) makes use of debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

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How Much Debt Does H World Group Carry?

The image below, which you can click on for greater detail, shows that H World Group had debt of CN¥9.40b at the end of March 2023, a reduction from CN¥10.1b over a year. On the flip side, it has CN¥9.06b in cash leading to net debt of about CN¥336.0m.

NasdaqGS:HTHT Debt to Equity History May 30th 2023

How Healthy Is H World Group's Balance Sheet?

The latest balance sheet data shows that H World Group had liabilities of CN¥13.4b due within a year, and liabilities of CN¥39.7b falling due after that. Offsetting these obligations, it had cash of CN¥9.06b as well as receivables valued at CN¥1.26b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥42.8b.

H World Group has a very large market capitalization of CN¥85.5b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. Carrying virtually no net debt, H World Group has a very light debt load indeed.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Looking at its net debt to EBITDA of 0.13 and interest cover of 3.4 times, it seems to us that H World Group is probably using debt in a pretty reasonable way. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. We also note that H World Group improved its EBIT from a last year's loss to a positive CN¥1.1b. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine H World Group's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Happily for any shareholders, H World Group actually produced more free cash flow than EBIT over the last year. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

H World Group's conversion of EBIT to free cash flow was a real positive on this analysis, as was its net debt to EBITDA. Having said that, its interest cover somewhat sensitizes us to potential future risks to the balance sheet. Considering this range of data points, we think H World Group is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. While H World Group didn't make a statutory profit in the last year, its positive EBIT suggests that profitability might not be far away. Click here to see if its earnings are heading in the right direction, over the medium term.

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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