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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.' 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 Condor Hospitality Trust, Inc. (NYSEMKT:CDOR) does use debt in its business. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to sure up its balance sheet. 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. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does Condor Hospitality Trust Carry?
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 However, because it has a cash reserve of US$4.68m, its net debt is less, at about US$130.5m.
A Look At Condor Hospitality Trust's Liabilities
According to the last reported balance sheet, Condor Hospitality Trust had liabilities of US$8.83m due within 12 months, and liabilities of US$135.5m due beyond 12 months. Offsetting these obligations, it had cash of US$4.68m as well as receivables valued at US$2.21m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$137.4m.
Given this deficit is actually higher than the company's market capitalization of US$98.7m, we think shareholders really should watch Condor Hospitality Trust's debt levels, like a parent watching their child ride a bike for the first time. 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.
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.
Weak interest cover of 0.90 times and a disturbingly high net debt to EBITDA ratio of 7.27 hit our confidence in Condor Hospitality Trust like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. 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. 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 Condor Hospitality Trust 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. Over the last three years, Condor Hospitality Trust actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.
We feel some trepidation about Condor Hospitality Trust's difficulty interest cover, but we've got positives to focus on, too. For example, its conversion of EBIT to free cash flow and EBIT growth rate give us some confidence in its ability to manage its debt. Taking the abovementioned factors together we do think Condor Hospitality Trust's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. Another positive for shareholders is that it pays dividends. So if you like receiving those dividend payments, check Condor Hospitality Trust's dividend history, without delay!
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.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
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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