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. Importantly, The Howard Hughes Corporation (NYSE:HHC) does carry debt. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free 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 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. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Howard Hughes's Debt?
As you can see below, at the end of June 2020, Howard Hughes had US$4.48b of debt, up from US$3.46b a year ago. Click the image for more detail. However, because it has a cash reserve of US$930.6m, its net debt is less, at about US$3.55b.
A Look At Howard Hughes's Liabilities
According to the last reported balance sheet, Howard Hughes had liabilities of US$827.8m due within 12 months, and liabilities of US$4.68b due beyond 12 months. Offsetting this, it had US$930.6m in cash and US$514.3m in receivables that were due within 12 months. So it has liabilities totalling US$4.06b more than its cash and near-term receivables, combined.
When you consider that this deficiency exceeds the company's US$3.48b market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive 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're focused on the future you can check out this free report showing analyst profit forecasts.
In the last year Howard Hughes had a loss before interest and tax, and actually shrunk its revenue by 44%, to US$847m. 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$58m at the EBIT level. When we look at that alongside the significant liabilities, we're not particularly confident 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$622m in negative free cash flow over the last year. So suffice it to say we consider the stock to be risky. 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. Case in point: We've spotted 3 warning signs for Howard Hughes you should be aware of, and 1 of them doesn't sit too well with us.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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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.
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