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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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Hostelworld Group plc (LON:HSW) makes use of debt. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Hostelworld Group's Debt?
As you can see below, at the end of June 2021, Hostelworld Group had €26.2m of debt, up from €3.45m a year ago. Click the image for more detail. But on the other hand it also has €33.7m in cash, leading to a €7.50m net cash position.
How Healthy Is Hostelworld Group's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Hostelworld Group had liabilities of €19.9m due within 12 months and liabilities of €28.2m due beyond that. On the other hand, it had cash of €33.7m and €932.0k worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by €13.4m.
Of course, Hostelworld Group has a market capitalization of €108.5m, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Hostelworld Group also has more cash than debt, so we're pretty confident it can manage its debt safely. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Hostelworld Group's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Over 12 months, Hostelworld Group made a loss at the EBIT level, and saw its revenue drop to €6.2m, which is a fall of 88%. To be frank that doesn't bode well.
So How Risky Is Hostelworld Group?
Statistically speaking companies that lose money are riskier than those that make money. And the fact is that over the last twelve months Hostelworld Group lost money at the earnings before interest and tax (EBIT) line. And over the same period it saw negative free cash outflow of €21m and booked a €51m accounting loss. Given it only has net cash of €7.50m, the company may need to raise more capital if it doesn't reach break-even soon. Summing up, we're a little skeptical of this one, as it seems fairly risky in the absence of free cashflow. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 2 warning signs for Hostelworld Group (1 shouldn't be ignored!) that you should be aware of before investing here.
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.
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.
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