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

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. Importantly, Royal Deluxe Holdings Limited (HKG:3789) does carry debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Royal Deluxe Holdings

What Is Royal Deluxe Holdings's Debt?

The image below, which you can click on for greater detail, shows that Royal Deluxe Holdings had debt of HK$28.2m at the end of September 2021, a reduction from HK$40.6m over a year. However, it does have HK$33.3m in cash offsetting this, leading to net cash of HK$5.11m.

How Strong Is Royal Deluxe Holdings' Balance Sheet?

The latest balance sheet data shows that Royal Deluxe Holdings had liabilities of HK$109.1m due within a year, and liabilities of HK$162.0k falling due after that. Offsetting this, it had HK$33.3m in cash and HK$285.0m in receivables that were due within 12 months. So it actually has HK$209.1m more liquid assets than total liabilities.

This surplus liquidity suggests that Royal Deluxe Holdings' balance sheet could take a hit just as well as Homer Simpson's head can take a punch. Having regard to this fact, we think its balance sheet is as strong as an ox. 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 if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

In the last year Royal Deluxe Holdings had a loss before interest and tax, and actually shrunk its revenue by 18%, to HK$684m. We would much prefer see growth.

So How Risky Is Royal Deluxe Holdings?

Although Royal Deluxe Holdings had an earnings before interest and tax (EBIT) loss over the last twelve months, it made a statutory profit of HK$20m. 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. The next few years will be important as the business matures. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 5 warning signs we've spotted with Royal Deluxe Holdings (including 1 which is potentially serious) .

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.