Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. We can see that The ONE Group Hospitality, Inc. (NASDAQ:STKS) does use debt in its business. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.
What Is ONE Group Hospitality's Net Debt?
As you can see below, at the end of June 2020, ONE Group Hospitality had US$64.0m of debt, up from US$12.3m a year ago. Click the image for more detail. However, because it has a cash reserve of US$23.5m, its net debt is less, at about US$40.6m.
How Strong Is ONE Group Hospitality's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that ONE Group Hospitality had liabilities of US$22.9m due within 12 months and liabilities of US$160.8m due beyond that. On the other hand, it had cash of US$23.5m and US$4.44m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$155.7m.
This deficit casts a shadow over the US$66.7m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, ONE Group Hospitality 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 future earnings, more than anything, that will determine ONE Group Hospitality'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.
In the last year ONE Group Hospitality wasn't profitable at an EBIT level, but managed to grow its revenue by 43%, to US$132m. With any luck the company will be able to grow its way to profitability.
Despite the top line growth, ONE Group Hospitality still had an earnings before interest and tax (EBIT) loss over the last year. To be specific the EBIT loss came in at US$520k. Considering that alongside the liabilities mentioned above make us nervous about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. Not least because it burned through US$1.8m in negative free cash flow over the last year. So suffice it to say we consider the stock to be 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. Take risks, for example - ONE Group Hospitality has 4 warning signs (and 2 which make us uncomfortable) we think 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.
If you decide to trade ONE Group Hospitality, use the lowest-cost* platform that is rated #1 Overall by Barron’s, Interactive Brokers. Trade stocks, options, futures, forex, bonds and funds on 135 markets, all from a single integrated account.
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.
*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email firstname.lastname@example.org.