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 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 Wyndham Hotels & Resorts, Inc. (NYSE:WH) makes use of debt. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does Wyndham Hotels & Resorts Carry?
The image below, which you can click on for greater detail, shows that Wyndham Hotels & Resorts had debt of US$2.03b at the end of March 2022, a reduction from US$2.59b over a year. However, it also had US$416.0m in cash, and so its net debt is US$1.61b.
A Look At Wyndham Hotels & Resorts' Liabilities
The latest balance sheet data shows that Wyndham Hotels & Resorts had liabilities of US$380.0m due within a year, and liabilities of US$2.75b falling due after that. Offsetting these obligations, it had cash of US$416.0m as well as receivables valued at US$238.0m due within 12 months. So it has liabilities totalling US$2.48b more than its cash and near-term receivables, combined.
This deficit isn't so bad because Wyndham Hotels & Resorts is worth US$6.94b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.
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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Wyndham Hotels & Resorts's debt is 2.7 times its EBITDA, and its EBIT cover its interest expense 6.0 times over. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. Pleasingly, Wyndham Hotels & Resorts is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 164% gain in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Wyndham Hotels & Resorts can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. Over the most recent three years, Wyndham Hotels & Resorts recorded free cash flow worth 51% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
Happily, Wyndham Hotels & Resorts's impressive EBIT growth rate implies it has the upper hand on its debt. But truth be told we feel its net debt to EBITDA does undermine this impression a bit. Looking at all the aforementioned factors together, it strikes us that Wyndham Hotels & Resorts can handle its debt fairly comfortably. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. 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. We've identified 2 warning signs with Wyndham Hotels & Resorts , and understanding them should be part of your investment process.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
What are the risks and opportunities for Wyndham Hotels & Resorts?
Earnings are forecast to grow 4.36% per year
Earnings grew by 85.1% over the past year
Significant insider selling over the past 3 months
Has a high level of debt
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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.