Here's Why Playa Hotels & Resorts (NASDAQ:PLYA) Can Afford Some 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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Playa Hotels & Resorts N.V. (NASDAQ:PLYA) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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.

See our latest analysis for Playa Hotels & Resorts

What Is Playa Hotels & Resorts's Net Debt?

As you can see below, Playa Hotels & Resorts had US$1.16b of debt at December 2021, down from US$1.30b a year prior. However, it does have US$270.1m in cash offsetting this, leading to net debt of about US$885.7m.

How Healthy Is Playa Hotels & Resorts' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Playa Hotels & Resorts had liabilities of US$105.3m due within 12 months and liabilities of US$1.32b due beyond that. Offsetting these obligations, it had cash of US$270.1m as well as receivables valued at US$53.4m due within 12 months. So it has liabilities totalling US$1.10b more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of US$1.44b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Playa Hotels & Resorts can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Over 12 months, Playa Hotels & Resorts reported revenue of US$529m, which is a gain of 95%, although it did not report any earnings before interest and tax. Shareholders probably have their fingers crossed that it can grow its way to profits.

Caveat Emptor

While we can certainly appreciate Playa Hotels & Resorts's revenue growth, its earnings before interest and tax (EBIT) loss is not ideal. Indeed, it lost US$69k at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. We would feel better if it turned its trailing twelve month loss of US$90m into a profit. So to be blunt we do think it is risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. We've identified 1 warning sign with Playa Hotels & Resorts , and understanding them should be part of your investment process.

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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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.