Royal Deluxe Holdings (HKG:3789) Has Debt But No Earnings; Should You Worry?

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Royal Deluxe Holdings Limited (HKG:3789) does carry debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Royal Deluxe Holdings

What Is Royal Deluxe Holdings's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2022 Royal Deluxe Holdings had HK$31.2m of debt, an increase on HK$28.2m, over one year. But on the other hand it also has HK$50.6m in cash, leading to a HK$19.4m net cash position.

A Look At Royal Deluxe Holdings' Liabilities

We can see from the most recent balance sheet that Royal Deluxe Holdings had liabilities of HK$169.2m falling due within a year, and liabilities of HK$137.0k due beyond that. On the other hand, it had cash of HK$50.6m and HK$305.1m worth of receivables due within a year. So it actually has HK$186.4m 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! 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.

In the last year Royal Deluxe Holdings had a loss before interest and tax, and actually shrunk its revenue by 23%, to HK$528m. To be frank that doesn't bode well.

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$15m. 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. There's no doubt the next few years will be crucial to how 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. For example, we've discovered 3 warning signs for Royal Deluxe Holdings (1 is significant!) that you should be aware of before investing here.

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.