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 Marriott International, Inc. (NASDAQ:MAR) does use debt in its business. 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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company’s debt levels is to consider its cash and debt together.
Our analysis indicates that MAR is potentially undervalued!
What Is Marriott International’s Debt?
As you can see below, Marriott International had US$9.28b of debt at September 2022, down from US$9.70b a year prior. However, it does have US$1.05b in cash offsetting this, leading to net debt of about US$8.23b.
A Look At Marriott International’s Liabilities
Zooming in on the latest balance sheet data, we can see that Marriott International had liabilities of US$7.11b due within 12 months and liabilities of US$16.6b due beyond that. Offsetting these obligations, it had cash of US$1.05b as well as receivables valued at US$2.38b due within 12 months. So its liabilities total US$20.3b more than the combination of its cash and short-term receivables.
While this might seem like a lot, it is not so bad since Marriott International has a huge market capitalization of US$51.3b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
Marriott International’s net debt of 2.5 times EBITDA suggests graceful use of debt. And the alluring interest cover (EBIT of 8.5 times interest expense) certainly does not do anything to dispel this impression. Notably, Marriott International’s EBIT launched higher than Elon Musk, gaining a whopping 123% on last year. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Marriott International’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.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it’s worth checking how much of that EBIT is backed by free cash flow. During the last three years, Marriott International generated free cash flow amounting to a very robust 87% of its EBIT, more than we’d expect. That puts it in a very strong position to pay down debt.
Our View
The good news is that Marriott International’s demonstrated ability to convert EBIT to free cash flow delights us like a fluffy puppy does a toddler. But, on a more sombre note, we are a little concerned by its net debt to EBITDA. Looking at the bigger picture, we think Marriott International’s use of debt seems quite reasonable and we’re not concerned about it. While debt does bring risk, when used wisely it can also bring a higher return on equity. 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. To that end, you should be aware of the 2 warning signs we’ve spotted with Marriott International .
At the end of the day, it’s often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It’s free.
What are the risks and opportunities for Marriott International?
Marriott International, Inc. operates, franchises, and licenses hotel, residential, and timeshare properties worldwide.
Rewards
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Trading at 20.5% below our estimate of its fair value
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Earnings are forecast to grow 10.9% per year
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Earnings grew by 361% over the past year
Risks
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Significant insider selling over the past 3 months
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Has a high level of debt
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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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