David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. We can see that The ONE Group Hospitality, Inc. (NASDAQ:STKS) does use debt in its business. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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.
How Much Debt Does ONE Group Hospitality Carry?
As you can see below, ONE Group Hospitality had US$23.6m of debt at March 2022, down from US$63.9m a year prior. But on the other hand it also has US$28.6m in cash, leading to a US$5.08m net cash position.
How Strong Is ONE Group Hospitality's Balance Sheet?
We can see from the most recent balance sheet that ONE Group Hospitality had liabilities of US$42.8m falling due within a year, and liabilities of US$129.2m due beyond that. On the other hand, it had cash of US$28.6m and US$8.66m worth of receivables due within a year. So it has liabilities totalling US$134.8m more than its cash and near-term receivables, combined.
ONE Group Hospitality has a market capitalization of US$276.1m, 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. While it does have liabilities worth noting, ONE Group Hospitality also has more cash than debt, so we're pretty confident it can manage its debt safely.
Better yet, ONE Group Hospitality grew its EBIT by 3,082% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. There's no doubt that we learn most about debt from the balance sheet. 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're focused on the future you can check out this free report showing analyst profit forecasts.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. ONE Group Hospitality may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the most recent three years, ONE Group Hospitality recorded free cash flow worth 61% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.
Although ONE Group Hospitality's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$5.08m. And it impressed us with its EBIT growth of 3,082% over the last year. So is ONE Group Hospitality's debt a risk? It doesn't seem so to us. 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. For example, we've discovered 3 warning signs for ONE Group Hospitality (1 is significant!) that you should be aware of before investing here.
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.
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.