Royal Deluxe Holdings (HKG:3789) Has A Rock Solid Balance Sheet

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 should shareholders be worried about its use of debt?

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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. 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

How Much Debt Does Royal Deluxe Holdings Carry?

The image below, which you can click on for greater detail, shows that Royal Deluxe Holdings had debt of HK$13.3m at the end of September 2023, a reduction from HK$31.2m over a year. But on the other hand it also has HK$61.9m in cash, leading to a HK$48.6m net cash position.

How Healthy Is Royal Deluxe Holdings' Balance Sheet?

The latest balance sheet data shows that Royal Deluxe Holdings had liabilities of HK$113.8m due within a year, and liabilities of HK$1.30m falling due after that. On the other hand, it had cash of HK$61.9m and HK$279.9m worth of receivables due within a year. So it actually has HK$226.7m 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!

We also note that Royal Deluxe Holdings improved its EBIT from a last year's loss to a positive HK$7.0m. The balance sheet is clearly the area to focus on when you are analysing debt. 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Royal Deluxe Holdings has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last year, Royal Deluxe Holdings actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While it is always sensible to investigate a company's debt, in this case Royal Deluxe Holdings has HK$48.6m in net cash and a strong balance sheet. The cherry on top was that in converted 381% of that EBIT to free cash flow, bringing in HK$27m. So is Royal Deluxe Holdings's debt a risk? It doesn't seem so to us. 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 learn about the 4 warning signs we've spotted with Royal Deluxe Holdings (including 2 which are a bit concerning) .

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.