Royale Home Holdings (HKG:1198) Is Making Moderate Use Of Debt

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 Royale Home Holdings Limited (HKG:1198) makes use of debt. But the real question is whether this debt is making the company risky.

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 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.

Check out our latest analysis for Royale Home Holdings

What Is Royale Home Holdings's Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2022 Royale Home Holdings had HK$2.97b of debt, an increase on HK$2.61b, over one year. However, because it has a cash reserve of HK$492.6m, its net debt is less, at about HK$2.47b.

How Strong Is Royale Home Holdings' Balance Sheet?

We can see from the most recent balance sheet that Royale Home Holdings had liabilities of HK$2.07b falling due within a year, and liabilities of HK$1.64b due beyond that. On the other hand, it had cash of HK$492.6m and HK$1.33b worth of receivables due within a year. So its liabilities total HK$1.88b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Royale Home Holdings is worth HK$3.77b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Royale Home Holdings will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year Royale Home Holdings wasn't profitable at an EBIT level, but managed to grow its revenue by 12%, to HK$1.7b. We usually like to see faster growth from unprofitable companies, but each to their own.

Caveat Emptor

Importantly, Royale Home Holdings had an earnings before interest and tax (EBIT) loss over the last year. To be specific the EBIT loss came in at HK$55m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. However, it doesn't help that it burned through HK$287m of cash over the last year. So suffice it to say we consider the stock very risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 2 warning signs with Royale Home Holdings (at least 1 which shouldn't be ignored) , 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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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.