Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital. 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. We note that Millennium & Copthorne Hotels New Zealand Limited (NZSE:MCK) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
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. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.
What Is Millennium & Copthorne Hotels New Zealand's Debt?
The image below, which you can click on for greater detail, shows that at December 2019 Millennium & Copthorne Hotels New Zealand had debt of NZ$67.0m, up from NZ$64.0m in one year. But it also has NZ$165.2m in cash to offset that, meaning it has NZ$98.2m net cash.
How Strong Is Millennium & Copthorne Hotels New Zealand's Balance Sheet?
We can see from the most recent balance sheet that Millennium & Copthorne Hotels New Zealand had liabilities of NZ$34.9m falling due within a year, and liabilities of NZ$166.3m due beyond that. Offsetting these obligations, it had cash of NZ$165.2m as well as receivables valued at NZ$21.1m due within 12 months. So it has liabilities totalling NZ$14.8m more than its cash and near-term receivables, combined.
Since publicly traded Millennium & Copthorne Hotels New Zealand shares are worth a total of NZ$379.7m, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Millennium & Copthorne Hotels New Zealand boasts net cash, so it's fair to say it does not have a heavy debt load!
While Millennium & Copthorne Hotels New Zealand doesn't seem to have gained much on the EBIT line, at least earnings remain stable for now. There's no doubt that we learn most about debt from the balance sheet. But it is Millennium & Copthorne Hotels New Zealand's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. Millennium & Copthorne Hotels New Zealand may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Looking at the most recent three years, Millennium & Copthorne Hotels New Zealand recorded free cash flow of 47% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.
While it is always sensible to look at a company's total liabilities, it is very reassuring that Millennium & Copthorne Hotels New Zealand has NZ$98.2m in net cash. So we don't have any problem with Millennium & Copthorne Hotels New Zealand's use of debt. Given Millennium & Copthorne Hotels New Zealand 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.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.
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