Is Royal Deluxe Holdings (HKG:3789) A Risky Investment?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Royal Deluxe Holdings

What Is Royal Deluxe Holdings's Net Debt?

The image below, which you can click on for greater detail, shows that Royal Deluxe Holdings had debt of HK$34.5m at the end of March 2022, a reduction from HK$42.7m over a year. However, it does have HK$72.0m in cash offsetting this, leading to net cash of HK$37.5m.

How Healthy Is Royal Deluxe Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Royal Deluxe Holdings had liabilities of HK$130.1m due within 12 months and liabilities of HK$132.0k due beyond that. Offsetting this, it had HK$72.0m in cash and HK$249.7m in receivables that were due within 12 months. So it actually has HK$191.4m more liquid assets than total liabilities.

This luscious liquidity implies that Royal Deluxe Holdings' balance sheet is sturdy like a giant sequoia tree. With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Succinctly put, Royal Deluxe Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

Notably, Royal Deluxe Holdings made a loss at the EBIT level, last year, but improved that to positive EBIT of HK$3.9m in the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Royal Deluxe Holdings will need earnings to service that debt. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Royal Deluxe Holdings may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last year, Royal Deluxe Holdings burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

While we empathize with investors who find debt concerning, the bottom line is that Royal Deluxe Holdings has net cash of HK$37.5m and plenty of liquid assets. So we don't have any problem with Royal Deluxe Holdings's use of debt. 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. To that end, you should learn about the 4 warning signs we've spotted with Royal Deluxe Holdings (including 1 which makes us a bit uncomfortable) .

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.

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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.