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.' 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. We can see that The Howard Hughes Corporation (NYSE:HHC) does use debt in its business. But should shareholders be worried about its use of debt?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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.
How Much Debt Does Howard Hughes Carry?
The chart below, which you can click on for greater detail, shows that Howard Hughes had US$4.49b in debt in June 2021; about the same as the year before. However, because it has a cash reserve of US$1.06b, its net debt is less, at about US$3.43b.
How Strong Is Howard Hughes' Balance Sheet?
According to the last reported balance sheet, Howard Hughes had liabilities of US$889.4m due within 12 months, and liabilities of US$4.72b due beyond 12 months. Offsetting these obligations, it had cash of US$1.06b as well as receivables valued at US$500.8m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$4.05b.
This deficit is considerable relative to its market capitalization of US$4.83b, so it does suggest shareholders should keep an eye on Howard Hughes' use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Howard Hughes can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
In the last year Howard Hughes had a loss before interest and tax, and actually shrunk its revenue by 8.9%, to US$771m. We would much prefer see growth.
Caveat Emptor
Over the last twelve months Howard Hughes produced an earnings before interest and tax (EBIT) loss. Indeed, it lost US$11m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. However, it doesn't help that it burned through US$56m 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. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 2 warning signs for Howard Hughes (1 shouldn't be ignored) you should be aware of.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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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