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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies The Howard Hughes Corporation (NYSE:HHC) makes use of debt. 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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does Howard Hughes Carry?
You can click the graphic below for the historical numbers, but it shows that as of December 2020 Howard Hughes had US$4.34b of debt, an increase on US$4.14b, over one year. However, because it has a cash reserve of US$1.01b, its net debt is less, at about US$3.32b.
How Strong Is Howard Hughes' Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Howard Hughes had liabilities of US$807.2m due within 12 months and liabilities of US$4.59b due beyond that. Offsetting this, it had US$1.01b in cash and US$449.9m in receivables that were due within 12 months. So its liabilities total US$3.93b more than the combination of its cash and short-term receivables.
This deficit is considerable relative to its market capitalization of US$5.15b, so it does suggest shareholders should keep an eye on Howard Hughes' use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. 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 Howard Hughes 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.
Over 12 months, Howard Hughes made a loss at the EBIT level, and saw its revenue drop to US$699m, which is a fall of 46%. To be frank that doesn't bode well.
Not only did Howard Hughes's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost US$128m 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. However, it doesn't help that it burned through US$74m of cash over the last year. So to be blunt we think it is risky. 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 Howard Hughes (1 makes us a bit uncomfortable!) that you should be aware of before investing here.
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.
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