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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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Chalet Hotels Limited (NSE:CHALET) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
See our latest analysis for Chalet Hotels
How Much Debt Does Chalet Hotels Carry?
The image below, which you can click on for greater detail, shows that Chalet Hotels had debt of ₹15.5b at the end of March 2019, a reduction from ₹27.3b over a year. However, because it has a cash reserve of ₹801.5m, its net debt is less, at about ₹14.7b.
How Healthy Is Chalet Hotels's Balance Sheet?
According to the last reported balance sheet, Chalet Hotels had liabilities of ₹7.25b due within 12 months, and liabilities of ₹14.1b due beyond 12 months. Offsetting these obligations, it had cash of ₹801.5m as well as receivables valued at ₹798.2m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹19.7b.
This deficit isn't so bad because Chalet Hotels is worth ₹64.5b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.
We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.