Health Check: How Prudently Does Royal Deluxe Holdings (HKG:3789) Use Debt?

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. As with many other companies Royal Deluxe Holdings Limited (HKG:3789) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Royal Deluxe Holdings

How Much Debt Does Royal Deluxe Holdings Carry?

The chart below, which you can click on for greater detail, shows that Royal Deluxe Holdings had HK$42.7m in debt in March 2021; about the same as the year before. However, it does have HK$87.1m in cash offsetting this, leading to net cash of HK$44.3m.

How Strong Is Royal Deluxe Holdings' Balance Sheet?

The latest balance sheet data shows that Royal Deluxe Holdings had liabilities of HK$166.3m due within a year, and liabilities of HK$299.0k falling due after that. Offsetting these obligations, it had cash of HK$87.1m as well as receivables valued at HK$273.3m due within 12 months. So it actually has HK$193.8m more liquid assets than total liabilities.

This luscious liquidity implies that Royal Deluxe Holdings' balance sheet is sturdy like a giant sequoia tree. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Succinctly put, Royal Deluxe Holdings boasts net cash, so it's fair to say it does not have a heavy debt load! There's no doubt that we learn most about debt from the balance sheet. But it is Royal Deluxe Holdings's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year Royal Deluxe Holdings wasn't profitable at an EBIT level, but managed to grow its revenue by 23%, to HK$870m. Shareholders probably have their fingers crossed that it can grow its way to profits.

So How Risky Is Royal Deluxe Holdings?

While Royal Deluxe Holdings lost money on an earnings before interest and tax (EBIT) level, it actually booked a paper profit of HK$37m. So when you consider it has net cash, along with the statutory profit, the stock probably isn't as risky as it might seem, at least in the short term. Given it also grew revenue by 23% over the last year, we think there's a good chance the company is on track. So this may well be an interesting business to watch grow. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. We've identified 4 warning signs with Royal Deluxe Holdings (at least 1 which is a bit concerning) , and understanding them should be part of your investment process.

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.

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