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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Trip.com Group Limited (NASDAQ:TCOM) does have debt on its balance sheet. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 Trip.com Group’s Debt?
The image below, which you can click on for greater detail, shows that Trip.com Group had debt of CN¥51.0b at the end of December 2021, a reduction from CN¥56.4b over a year. However, because it has a cash reserve of CN¥49.4b, its net debt is less, at about CN¥1.58b.
A Look At Trip.com Group’s Liabilities
We can see from the most recent balance sheet that Trip.com Group had liabilities of CN¥66.2b falling due within a year, and liabilities of CN¥15.2b due beyond that. Offsetting these obligations, it had cash of CN¥49.4b as well as receivables valued at CN¥10.6b due within 12 months. So its liabilities total CN¥21.4b more than the combination of its cash and short-term receivables.
Trip.com Group has a very large market capitalization of CN¥92.0b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it’s clear that we should definitely closely examine whether it can manage its debt without dilution. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Trip.com Group’s ability to maintain a healthy balance sheet going forward.
Over 12 months, Trip.com Group reported revenue of CN¥20b, which is a gain of 9.3%, although it did not report any earnings before interest and tax. That rate of growth is a bit slow for our taste, but it takes all types to make a world.
Importantly, Trip.com Group had an earnings before interest and tax (EBIT) loss over the last year. To be specific the EBIT loss came in at CN¥1.4b. 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. We would feel better if it turned its trailing twelve month loss of CN¥550m into a profit.