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. Importantly, Wyndham Hotels & Resorts, Inc. (NYSE:WH) does carry debt. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Wyndham Hotels & Resorts's Debt?
As you can see below, Wyndham Hotels & Resorts had US$2.07b of debt, at June 2019, which is about the same the year before. You can click the chart for greater detail. However, it also had US$107.0m in cash, and so its net debt is US$1.97b.
How Strong Is Wyndham Hotels & Resorts's Balance Sheet?
The latest balance sheet data shows that Wyndham Hotels & Resorts had liabilities of US$481.0m due within a year, and liabilities of US$2.88b falling due after that. Offsetting these obligations, it had cash of US$107.0m as well as receivables valued at US$354.0m due within 12 months. So its liabilities total US$2.90b more than the combination of its cash and short-term receivables.
This deficit is considerable relative to its market capitalization of US$4.81b, so it does suggest shareholders should keep an eye on Wyndham Hotels & Resorts's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.
We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Wyndham Hotels & Resorts has a debt to EBITDA ratio of 3.6 and its EBIT covered its interest expense 4.3 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Looking on the bright side, Wyndham Hotels & Resorts boosted its EBIT by a silky 31% in the last year. Like the milk of human kindness that sort of growth increases resilience, making the company more capable of managing debt. The balance sheet is clearly the area to focus on when you are analysing debt. 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.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. In the last three years, Wyndham Hotels & Resorts's free cash flow amounted to 37% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.
On our analysis Wyndham Hotels & Resorts's EBIT growth rate should signal that it won't have too much trouble with its debt. However, our other observations weren't so heartening. For example, its net debt to EBITDA makes us a little nervous about its debt. Looking at all this data makes us feel a little cautious about Wyndham Hotels & Resorts's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. We'd be motivated to research the stock further if we found out that Wyndham Hotels & Resorts insiders have bought shares recently. If you would too, then you're in luck, since today we're sharing our list of reported insider transactions for free.
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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