Stock Analysis

Is Wyndham Hotels & Resorts (NYSE:WH) A Risky Investment?

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NYSE:WH
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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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Wyndham Hotels & Resorts, Inc. (NYSE:WH) does use debt in its business. But the more important question is: how much risk is that debt creating?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Wyndham Hotels & Resorts

What Is Wyndham Hotels & Resorts's Net Debt?

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 December 2021, a reduction from US$2.61b over a year. However, because it has a cash reserve of US$171.0m, its net debt is less, at about US$1.86b.

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NYSE:WH Debt to Equity History February 18th 2022

How Strong Is Wyndham Hotels & Resorts' Balance Sheet?

The latest balance sheet data shows that Wyndham Hotels & Resorts had liabilities of US$376.0m due within a year, and liabilities of US$2.80b falling due after that. Offsetting this, it had US$171.0m in cash and US$246.0m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$2.76b.

This deficit isn't so bad because Wyndham Hotels & Resorts is worth US$8.07b, 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.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its 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 has a debt to EBITDA ratio of 3.4 and its EBIT covered its interest expense 4.9 times. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. Notably, Wyndham Hotels & Resorts's EBIT launched higher than Elon Musk, gaining a whopping 119% on last year. There's no doubt that we learn most about debt from the balance sheet. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Looking at the most recent three years, Wyndham Hotels & Resorts recorded free cash flow of 42% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

On our analysis Wyndham Hotels & Resorts's EBIT growth rate should signal that it won't have too much trouble with its debt. But the other factors we noted above weren't so encouraging. For example, its net debt to EBITDA makes us a little nervous about its debt. When we consider all the elements mentioned above, it seems to us that Wyndham Hotels & Resorts is managing its debt quite well. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 3 warning signs with Wyndham Hotels & Resorts , and understanding them should be part of your investment process.

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.

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