The external fund manager backed by Berkshire Hathaway’s Charlie Munger, Li Lu, makes no bones about it when he says ‘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. We can see that Event Hospitality & Entertainment Limited () does use debt in its business. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can’t fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company’s use of debt, we first look at cash and debt together.
What Is Event Hospitality & Entertainment’s Debt?
You can click the graphic below for the historical numbers, but it shows that as of December 2020 Event Hospitality & Entertainment had AU$532.5m of debt, an increase on AU$405.4m, over one year. On the flip side, it has AU$81.3m in cash leading to net debt of about AU$451.2m.
How Healthy Is Event Hospitality & Entertainment’s Balance Sheet?
According to the last reported balance sheet, Event Hospitality & Entertainment had liabilities of AU$370.5m due within 12 months, and liabilities of AU$1.35b due beyond 12 months. Offsetting this, it had AU$81.3m in cash and AU$93.4m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$1.54b.
This deficit is considerable relative to its market capitalization of AU$1.87b, so it does suggest shareholders should keep an eye on Event Hospitality & Entertainment’s use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Event Hospitality & Entertainment’s ability to maintain a healthy balance sheet going forward. So if you’re focused on the future you can check out this free.
Over 12 months, Event Hospitality & Entertainment made a loss at the EBIT level, and saw its revenue drop to AU$283m, which is a fall of 76%. To be frank that doesn’t bode well.
While Event Hospitality & Entertainment’s falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost a very considerable AU$218m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. However, it doesn’t help that it burned through AU$47m of cash over the last year. So to be blunt we think it is risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example – Event Hospitality & Entertainment haswe think you should be aware of.
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