Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from synonymous with risk.” So it seems smart money knows that debt – which is usually involved in bankruptcies – is a very important factor when you’re assessing a company’s risk. We can see that Haidilao International Holding Ltd. (HKG:6862) uses debt in his business. But should shareholders worry about its use of debt?
Why is debt risky?
Generally speaking, debt only becomes a real problem when a company cannot easily repay it, either by raising capital or with its own cash flow. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. Of course, many companies use debt to finance their growth, without any negative consequences. When we think about a company’s use of debt, we first look at cash and debt together.
Check out our latest analysis for Haidilao International Holding
What is the debt of Haidilao International Holding?
The image below, which you can click on for more details, shows that in December 2021, Haidilao International Holding had a debt of 7.69 billion Canadian yen, compared to 4.07 billion Canadian yen in one year . However, he also had 6.50 billion Canadian yen in cash, so his net debt is 1.18 billion domestic yen.
How strong is Haidilao International Holding’s balance sheet?
The latest balance sheet data shows that Haidilao International Holding had liabilities of 9.89 billion yen maturing within one year, and liabilities of 10.2 billion yen maturing thereafter. In compensation for these obligations, it had cash of 6.50 billion yen as well as receivables valued at 1.54 billion yen due within 12 months. It therefore has liabilities totaling 12.0 billion Canadian yen more than its cash and short-term receivables, combined.
Of course, Haidilao International Holding has a titanic market capitalization of 63.9 billion Canadian yen, so those liabilities are probably manageable. That said, it is clear that we must continue to monitor its record, lest it deteriorate.
In order to assess a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its expenses. interest (its interest coverage). Thus, we consider debt to earnings with and without amortization and depreciation expense.
Given that net debt is only 0.50 times EBITDA, it is initially surprising to see that Haidilao International Holding’s EBIT has a low interest coverage of 0.38 times. So either way, it’s clear that debt levels are not negligible. Shareholders should know that Haidilao International Holding’s EBIT fell 81% last year. If this earnings trend continues, paying off debt will be about as easy as herding cats on a roller coaster. There is no doubt that we learn the most about debt from the balance sheet. But ultimately, the company’s future profitability will decide whether Haidilao International Holding can strengthen its balance sheet over time. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.
Finally, while the taxman may love accounting profits, lenders only accept cash. So the logical step is to look at what proportion of that EBIT is actual free cash flow. Over the past three years, Haidilao International Holding has burned a lot of money. While this may be the result of spending for growth, it makes debt much riskier.
Our point of view
At first glance, Haidilao International Holding’s conversion of EBIT to free cash flow left us hesitant about the stock, and its EBIT growth rate was no more attractive than the single empty restaurant la busiest night of the year. But on the bright side, its net debt to EBITDA is a good sign and makes us more optimistic. Looking at the big picture, it seems clear to us that the use of debt by Haidilao International Holding creates risks for the company. If all goes well, it can pay off, but the downside of this debt is a greater risk of permanent losses. The balance sheet is clearly the area to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist outside of the balance sheet. For example, we found 2 warning signs for Haidilao International Holding which you should be aware of before investing here.
In the end, it’s often best to focus on companies that aren’t in debt. You can access our special list of these companies (all with a track record of earnings growth). It’s free.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.