Introduction
I recently saw an interview on CNBC TV18 where the representative from Chalet Hotels was present. The host asked a pointed question about the company’s hefty Rs.2,554.30 crore loan book.
The representative calmly responded, saying the debt is within a “3x EBITDA” limit, which makes it manageable.
When I heard that description of the loan book, I thought, what’s so special about this Debt/EBITDA ratio?
Why didn’t he lean on other metrics like Debt-to-Equity (D/E) or Interest Coverage Ratio (ICR)?
He could also have used the metric Profit After Tax (PAT), instead of EBITDA, to compare the company’s debt. Whey he specifically used the EBITDA metric?
After reading this post you’ll see why the representative made this choice and what it tells us about financial storytelling. To reach there, we’ll have to first understand the basics.
What Is Debt/EBITDA Ratio?
EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization.
In terms of a formula, it looks like below:
EBITDA = Net Profit (PAT) + Tax + Interest + D&A
EBITDA is a measure of a company’s core operating profit.
It does not adjusts the total income of the company for non-operational expenses like taxes, interest, and deprecision.
The Debt/EBITDA ratio tells us how many years it would take a company to pay off its debt if it used all its EBITDA for that purpose.
For Chalet Hotels, the numbers are as follows:
- Total Debt: Rs.2,554.30 crore
- EBITDA: Rs.772.19 crore
- Debt/EBITDA: 3.31
This means it would take roughly 3.3 years for Chalet Hotels to clear its debt if it funneled all its EBITDA into repayments.
The representative said he’s comfortable because the ratio is within “3x EBITDA.”
But why the multiple of 3x is so important?
In many industries, including hospitality, a Debt/EBITDA ratio below 3 is considered healthy. It signals that the company generates enough cash flow to manage its debt without any problem.
The thumb rule is, a ratio above 4 or 5 is a red flags. It suggests the debt burden is heavy relative to earnings.
Why 3x EBITDA Is a Sweet Spot?
The representative’s confidence in the 3.31 Debt/EBITDA ratio isn’t just a random number, it has roots in financial logic.
Let me explain the utility of 3x multiple with an analogy.
Consider your net take home salary Rs.1 lakh a month and have a home loan of Rs.36 lakh.
Your loan is 3x your annual income (Rs.12 lakh).
In theory, if you dedicate all your income to the loan, you’d clear your outstanding in three years. Over the past years, experts have arrived at this theory that a 3 year loan-payback period is the sweet spot.
Now, if your loan were Rs.60 lakh (5x your income). It would take five years to payback this loan. This is where it starts to sound risky. The quantum of the loan that you would need five years to make zero, points at excess debt burden.
For Chalet Hotels, a Debt/EBITDA of 3.31 is close to that comfortable threshold. It tells investors and lenders that the company’s operating cash flow is strong enough to handle its debt.
We must also undestand that some type of business need debt to run its operations.
For example, hospitality is a capital-intensive business. Imagine a hotel business and you will see the following:
- Building & operating hotels,
- Maintaining properties, and
- Expanding portfolios.
Debt is part of the game when we are talking about a hotel business.
But a ratio near 3x shows that Chalet’s operations are robust enough to cover its obligations without straining its finances.
It’s a signal of stability, especially in a cyclical industry like hospitality where demand can fluctuate.
Why Not Use Debt-to-Equity (D/E)?
Now, let’s talk about why the representative didn’t lean on the Debt-to-Equity (D/E) ratio.
For Chalet Hotels, D/E is 0.84 for Chalet Hotels.
The D/E ratio compares a company’s total debt to its shareholders’ equity (net worth). A D/E of 0.84 means for every Rs.1 of equity, there’s Rs.0.84 of debt.
That’s actually a good number for a capital intensive business like hotels. You will find most companies in capital-heavy sectors like hospitality have D/E ratios close to two (2).
So what do you think, why the representative of Chalet hotels didn’t he use D/E to present a perspective of its debt load?
We cannot know for sure, but allow me to repsent to your my views on it.
- The Net Worth Factor: The D/E ratio focuses on the balance sheet, showing how much leverage a company has relative to its owners’ stake. It’s great for understanding the capital structure but doesn’t directly tell you about cash flow or the ability to service debt. Imagine this, you’re explaining your home loan to a friend. You saying, “My loan is less than my net worth.” This sounds nice, but it doesn’t answer the key question: “Can you afford the EMI?”
- The Cash Factor: That’s where Debt/EBITDA sounds much more contincing. If one wants to know if you can afford a debt or not, cash flow can answer the best. Cash is a very critical component for debt repayment.
In Chalet’s case, the D/E of 0.84 is solid, but it’s static and a non-cash number. Hence, it doesn’t capture how efficiently the company generates cash to cover its loans.
The representative likely chose Debt/EBITDA to emphasize operational strength over balance sheet structure.
This was especially necessary since investors in hospitality care about cash flow in a cyclical market.
What About Interest Coverage Ratio (ICR)?
Another metric the representative could have used is the Interest Coverage Ratio (ICR), which is 4.84 for Chalet Hotels.
ICR measures how easily a company can pay the interest on its debt using its earnings (usually EBIT, or Earnings Before Interest and Taxes). We can also express EBIT as shown in the below formula:
EBIT = EBITDA – D&A
An ICR of 4.84 means Chalet’s EBIT is 4.84 times its interest expenses. That’s a strong number. Anything above 3 is generally seen as healthy.
So why skip ICR?
While ICR is great for showing whether a company can cover its interest payments, it’s narrower than Debt/EBITDA.
It only looks at interest, not the principal amount of the debt.
Think of the this as list in the following points:
- ICR tells you if you can pay your loan’s interest each month.
- But Debt/EBITDA tells you how manageable the entire loan is.
Banks need interest to be paid, but essentially they need us to pay back the whole EMI, not just the interest component of the EMI, right?
For a company like Chalet, with a large debt of Rs.2,554.30 crore, investors want assurance that the total debt load is sustainable, not just the interest.
Debt/EBITDA gives a fuller picture, which is likely why the representative leaned on it.
Why Not Use Net Profit (PAT)?
Now, let’s address Profit After Tax (PAT), which is Rs.285.05 crore for Chalet Hotels.
PAT is the net profit after all expenses, including interest, taxes, and depreciation. It’s what’s left for shareholders.
Net Profit (PAT) = EBITDA – Depreciation – Interest – Tax
Could the representative have used PAT to justify the debt? Sure, he could’ve said, “Our PAT is Rs.285.05 crore, so our debt of Rs.2,554.30 crore is about 8.96 times our net profit.”
But that wouldn’t have been as compelling. Why? Two main reasons:
- PAT includes non-operational items like taxes and depreciation, which can distort the picture of a company’s ability to service debt.
- PAT also included Depreciation. It is a big deal in hospitality because hotels are asset-heavy. They are obliged to book heavy depreciation expense for buildings and furnishings. They are non-cash expenses. What does it mean? It means, there is not cash out actually happening on account of depreciation, its only an accounting adjustment. The actual cash out-flow has already happened long time back.
Using PAT would understate Chalet’s cash-generating ability.
EBITDA, on the other hand, strips out these non-cash and non-operational expenses, giving a clearer view of the cash available to tackle debt.
Let me give you another analogy to explain this point. Consider your monthly income is Rs.25,000. Now, you want to take a home lon of Rs.30 Lakhs. If you will only tell the bank your monthly income, you’ll probably not get the loan.
But say, you also consistently earn about Rs.1 Lakhs from a side hustle. Now you see, how the whole situation is turning in your favour? In this situation, I think no bank will refuse to issue you a home loan.
Using this analogy for understanding, view PAT and EBITDA as follows:
- PAT is your monthly income.
- EBITDA is your monthly income plus income from side hustle.
The side hustle increases your ability to generate cash. It thereby substantially enhances your loan affordability.
Conclusion
Perhaps, the representative of Chalt Hotel knew the power of using the right metric to justify the debt load of its balance sheet.
The Chalet Hotels representative’s choice of Debt/EBITDA wasn’t random.
It’s a metric that speaks directly about the company’s ability to manage its Rs.2,554.30 crore debt through its operating cash flow.
It’s a clearer, more dynamic measure than the following:
- D/E, which is static, or
- ICR, which is limited to interest.
- PAT, while important, gets clouded by non-cash items, making it less relevant for debt discussions.
By focusing on Debt/EBITDA, the representative told a compelling story of financial health, tailored to what investors and analysts care about most.
Next time you hear a company rep talk about debt, pay attention to the metrics they choose. Are they picking the one that best reflects their strengths? Or are they dodging tougher questions?
For Chalet Hotels, the 3x EBITDA benchmark was a smart move—a concise way to say, “Our debt is big, but our cash flow is bigger.”
What do you think about my take on the Debt/EBITDA ratio’s usage to define debt load? Let me know in the comments section below.
