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. 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. As with many other companies Associated International Hotels Limited (HKG:105) makes use of debt. But should shareholders be worried about its use of debt?
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. 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 shore 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. When we think about a company's use of debt, we first look at cash and debt together.
What Is Associated International Hotels's Net Debt?
The chart below, which you can click on for greater detail, shows that Associated International Hotels had HK$200.0m in debt in March 2019; about the same as the year before. But on the other hand it also has HK$511.3m in cash, leading to a HK$311.3m net cash position.
How Strong Is Associated International Hotels's Balance Sheet?
The latest balance sheet data shows that Associated International Hotels had liabilities of HK$232.2m due within a year, and liabilities of HK$280.2m falling due after that. Offsetting this, it had HK$511.3m in cash and HK$15.5m in receivables that were due within 12 months. So it actually has HK$14.4m more liquid assets than total liabilities.
This state of affairs indicates that Associated International Hotels's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the HK$7.63b company is short on cash, but still worth keeping an eye on the balance sheet. Simply put, the fact that Associated International Hotels has more cash than debt is arguably a good indication that it can manage its debt safely.
But the other side of the story is that Associated International Hotels saw its EBIT decline by 4.4% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Associated International Hotels will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Associated International Hotels has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Associated International Hotels generated free cash flow amounting to a very robust 85% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.
While it is always sensible to investigate a company's debt, in this case Associated International Hotels has HK$311.3m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of HK$412m, being 85% of its EBIT. So we don't think Associated International Hotels's use of debt is risky. Another positive for shareholders is that it pays dividends. So if you like receiving those dividend payments, check Associated International Hotels's dividend history, without delay!
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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 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. Thank you for reading.