We think 1957 (Hospitality) (HKG:8495) can manage debt with ease

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.” It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. Like many other companies 1957 & Co. (Hospitality) Limited (HKG:8495) uses debt. 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. If things go really bad, lenders can take over the business. However, a more common (but still costly) situation is when a company has to dilute shareholders at a cheap share price just to keep debt under control. That said, the most common situation is when a company manages its debt reasonably well – and to its own benefit. When we look at debt levels, we first consider cash and debt levels, together.

Discover our latest analysis for 1957 (Hospitality)

What is the debt for 1957 (Hospitality)?

As you can see below, 1957 (Hospitality) had a debt of HK$80.8 million in December 2021, compared to HK$127.7 million the previous year. However, his balance sheet shows that he holds HK$98.8 million in cash, so he actually has HK$18.0 million in cash.

SEHK: 8495 Historical Debt to Equity 31 May 2022

How healthy is the balance sheet for 1957 (hotels)?

Zooming in on the latest balance sheet data, we can see that 1957 (Hospitality) had liabilities of HK$114.3 million due within 12 months and liabilities of HK$18.8 million due beyond. As compensation for these obligations, it had liquid assets of HK$98.8 million as well as receivables valued at HK$7.83 million and payable within 12 months. It therefore has liabilities totaling HK$26.5 million more than its cash and short-term receivables, combined.

Of course, 1957 (Hospitality) has a market cap of HK$178.6 million, so those liabilities are probably manageable. However, we think it’s worth keeping an eye on the strength of its balance sheet, as it can change over time. While he has liabilities worth noting, 1957 (Hospitality) also has more cash than debt, so we’re pretty confident he can manage his debt safely.

Fortunately, 1957 (Hospitality) is growing its EBIT faster than former Australian Prime Minister Bob Hawke dropped a yard glass, with a 489% gain over the last twelve months. There is no doubt that we learn the most about debt from the balance sheet. But it is the profits of 1957 (Hospitality) that will influence the holding of the balance sheet in the future. So, when considering debt, it is definitely worth looking at the earnings trend. Click here for an interactive preview.

Finally, while the taxman may love accounting profits, lenders only accept cash. Although 1957 (Hospitality) has net cash on its balance sheet, it is still worth looking at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it builds (or erodes) this cash balance. Over the past two years, 1957 (Hospitality) has actually produced more free cash flow than EBIT. There’s nothing better than incoming money to stay in the good books of your lenders.

Summary

Although 1957 (Hospitality)’s balance sheet is not particularly strong, due to total liabilities, it is clearly positive to see that it has a net cash position of HK$18.0 million. And it impressed us with a free cash flow of HK$100 million, or 1,997% of its EBIT. So is the 1957 debt (Hospitality) a risk? This does not seem to us to be the case. When analyzing debt levels, the balance sheet is the obvious starting point. But at the end of the day, every business can contain risks that exist outside of the balance sheet. Know that 1957 (Hospitality) shows 2 warning signs in our investment analysis you should know…

Of course, if you’re the type of investor who prefers to buy stocks without the burden of debt, then feel free to check out our exclusive list of cash-efficient growth stocks today.

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.

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