We believe Choice Hotels International (NYSE: CHH) can stay on top of its debt

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David Iben put it well when he said: “Volatility is not a risk we care about. What matters to us is to avoid the permanent loss of capital. ‘ It’s only natural to consider a company’s balance sheet when looking at its level of risk, as debt is often involved when a business collapses. Above all, Choice Hotels International, Inc. (NYSE: CHH) is in debt. But does this debt worry shareholders?

When is debt dangerous?

Debts and other liabilities become risky for a business when it cannot easily meet these obligations, either with free cash flow or by raising capital at an attractive price. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. However, a more common (but still painful) scenario is that he must raise new equity at low cost, thereby diluting shareholders over the long term. That said, the most common situation is where a business manages its debt reasonably well – and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash flow and debt together.

What is Choice Hotels International’s net debt?

As you can see below, Choice Hotels International had $ 1.06 billion in debt in June 2021, up from $ 1.24 billion the year before. However, it has US $ 308.0 million in cash offsetting this, which leads to net debt of around US $ 751.6 million.

NYSE: CHH Debt to Equity History November 6, 2021

A look at the responsibilities of Choice Hotels International

The latest balance sheet data shows that Choice Hotels International had liabilities of US $ 316.0 million due within one year, and liabilities of US $ 1.31 billion due thereafter. On the other hand, it had US $ 308.0 million in cash and US $ 272.3 million in receivables due within one year. As a result, its liabilities exceed the sum of its cash and (short-term) receivables by US $ 1.04 billion.

Given that the listed shares of Choice Hotels International are worth a total of US $ 8.24 billion, it seems unlikely that this level of liabilities is a major threat. Having said that, it is clear that we must continue to monitor his record lest it get worse.

We use two main ratios to inform us about the levels of debt compared to earnings. The first is net debt divided by earnings before interest, taxes, depreciation, and amortization (EBITDA), while the second is the number of times its profit before interest and taxes (EBIT) covers its interest expense (or its coverage of interest, for short). Thus, we consider debt versus earnings with and without amortization charges.

Choice Hotels International has a debt to EBITDA ratio of 2.6 and its EBIT covered its interest expense 5.9 times. This suggests that while debt levels are significant, we would stop calling them problematic. One way that Choice Hotels International could beat its debt would be to stop borrowing more but continue to increase its EBIT by around 11%, as it did last year. The balance sheet is clearly the area you need to focus on when analyzing debt. But it is future profits, more than anything, that will determine Choice Hotels International’s ability to maintain a healthy balance sheet in the future. So, if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.

Finally, while the IRS may love accounting profits, lenders only accept hard cash. The logical step is therefore to examine the proportion of this EBIT that corresponds to the actual free cash flow. Over the past three years, Choice Hotels International has recorded free cash flow of 41% of its EBIT, which is lower than expected. This low cash conversion makes debt management more difficult.

Our point of view

Choice Hotels International’s ability to increase its EBIT and total liability level has bolstered our ability to manage debt. That said, its net debt to EBITDA does make us somewhat aware of potential future risks to the balance sheet. When we consider all the elements mentioned above, it seems to us that Choice Hotels International is managing its debt quite well. But beware: we believe debt levels are high enough to warrant continued monitoring. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist off the balance sheet. Concrete example: we have spotted 2 warning signs for Choice Hotels International you must be aware of this, and one of them must not be ignored.

At the end of the day, sometimes it’s easier to focus on businesses that don’t even need to go into debt. Readers can access a list of growth stocks with zero net debt 100% free, at present.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.

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