Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 The Hongkong and Shanghai Hotels, Limited (HKG:45) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Hongkong and Shanghai Hotels

What Is Hongkong and Shanghai Hotels's Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2021 Hongkong and Shanghai Hotels had HK$13.4b of debt, an increase on HK$11.2b, over one year. However, it also had HK$479.0m in cash, and so its net debt is HK$12.9b.

A Look At Hongkong and Shanghai Hotels' Liabilities

Zooming in on the latest balance sheet data, we can see that Hongkong and Shanghai Hotels had liabilities of HK$3.76b due within 12 months and liabilities of HK$15.1b due beyond that. On the other hand, it had cash of HK$479.0m and HK$378.0m worth of receivables due within a year. So it has liabilities totalling HK$18.0b more than its cash and near-term receivables, combined.

When you consider that this deficiency exceeds the company's HK$12.7b market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Hongkong and Shanghai Hotels's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Over 12 months, Hongkong and Shanghai Hotels reported revenue of HK$3.5b, which is a gain of 28%, although it did not report any earnings before interest and tax. Shareholders probably have their fingers crossed that it can grow its way to profits.

Caveat Emptor

Despite the top line growth, Hongkong and Shanghai Hotels still had an earnings before interest and tax (EBIT) loss over the last year. To be specific the EBIT loss came in at HK$105m. Considering that alongside the liabilities mentioned above make us nervous about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. Not least because it had negative free cash flow of HK$662m over the last 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.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.