Hotels in Hong Kong and Shanghai (HKG: 45) have debt but no revenue; Should you be worried?

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 note that Hong Kong and Shanghai Hotels, Limited (HKG:45) has a debt on its balance sheet. But should shareholders worry about its use of debt?

What risk does debt carry?

Debt and other liabilities become risky for a business when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. Although not too common, we often see companies in debt permanently diluting their shareholders because lenders force them to raise capital at a ridiculous price. By replacing dilution, however, debt can be a great tool for companies that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business has is to look at its cash and debt together.

See our latest analysis for Hongkong and Shanghai Hotels

How much debt do Hong Kong and Shanghai hotels have?

As you can see below, at the end of December 2021, hotels in Hong Kong and Shanghai had a debt of HK$13.4 billion, compared to HK$11.2 billion a year ago. Click on the image for more details. However, since it has a cash reserve of HK$479.0 million, its net debt is lower at around HK$12.9 billion.

How healthy are the balance sheets of hotels in Hong Kong and Shanghai?

According to the latest published balance sheet, hotels in Hong Kong and Shanghai had liabilities of HK$3.76 billion due within 12 months and liabilities of HK$15.1 billion due beyond 12 months. On the other hand, it had cash of HK$479.0 million and HK$378.0 million of receivables within one year. It therefore has liabilities totaling HK$18.0 billion more than its cash and short-term receivables, combined.

Given that this deficit is actually larger than the company’s market capitalization of HK$13.8 billion, we think shareholders should really be watching Hong Kong and Shanghai hotel debt levels, like a parent who watches her child ride a bike for the first time. In the scenario where the company were to quickly clean up its balance sheet, it seems likely that shareholders would suffer significant dilution. 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 Hongkong and Shanghai Hotels 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.

Last year, Hong Kong and Shanghai Hotels was not profitable in terms of EBIT, but managed to increase its turnover by 28%, to HK$3.5 billion. With a little luck, the company will be able to progress towards profitability.

Caveat Emptor

While we can certainly appreciate Hongkong and Shanghai Hotels’ revenue growth, its earnings before interest and tax (EBIT) loss is less than ideal. To be precise, the EBIT loss amounted to HK$105 million. Considering that alongside the liabilities mentioned above, we are nervous about the business. It would have to quickly improve its functioning so that we are interested in it. Not least because it had a negative free cash flow of HK$662 million over the past twelve months. That means it’s on the risky side of things. For riskier companies like Hongkong and Shanghai Hotels, I always like to keep an eye on whether insiders are buying or selling. So click here if you want to find out for yourself.

If you are interested in investing in businesses that can generate profits without the burden of debt, then check out this free list of growing companies that have net cash on the balance sheet.

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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.