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Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. Importantly, Condor Hospitality Trust, Inc. (NYSEMKT:CDOR) does carry debt. But the real question is whether this debt is making the company risky.
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. If things get really bad, the lenders can take control of the business. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Condor Hospitality Trust's Net Debt?
You can click the graphic below for the historical numbers, but it shows that Condor Hospitality Trust had US$135.2m of debt in March 2019, down from US$142.9m, one year before On the flip side, it has US$4.68m in cash leading to net debt of about US$130.5m.
A Look At Condor Hospitality Trust's Liabilities
We can see from the most recent balance sheet that Condor Hospitality Trust had liabilities of US$8.83m falling due within a year, and liabilities of US$135.5m due beyond that. Offsetting this, it had US$4.68m in cash and US$2.21m in receivables that were due within 12 months. So its liabilities total US$137.4m more than the combination of its cash and short-term receivables.
When you consider that this deficiency exceeds the company's US$98.7m market capitalization, you might well be inclined to review the balance sheet, just like one might study a new partner's social media. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. Either way, since Condor Hospitality Trust does have more debt than cash, it's worth keeping an eye on its balance sheet.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
Condor Hospitality Trust shareholders face the double whammy of a high net debt to EBITDA ratio (7.27), and fairly weak interest coverage, since EBIT is just 0.90 times the interest expense. The debt burden here is substantial. The good news is that Condor Hospitality Trust grew its EBIT a smooth 32% over the last twelve months. Like a mother's loving embrace of a newborn that sort of growth builds resilience, putting the company in a stronger position to manage its debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Condor Hospitality Trust 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.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Happily for any shareholders, Condor Hospitality Trust actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.
While Condor Hospitality Trust's interest cover has us nervous. To wit both its conversion of EBIT to free cash flow and EBIT growth rate were encouraging signs. When we consider all the factors discussed, it seems to us that Condor Hospitality Trust is taking some risks with its use of debt. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. Given Condor Hospitality Trust has a strong balance sheet is profitable and pays a dividend, it would be good to know how fast its dividends are growing, if at all. You can find out instantly by clicking this link.
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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If you spot an error that warrants correction, please contact the editor at email@example.com. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.
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