These 4 Measures Indicate That Regina Miracle International (Holdings) (HKG:2199) Is Using Debt Extensively

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Regina Miracle International (Holdings) Limited (HKG:2199) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

See our latest analysis for Regina Miracle International (Holdings)

What Is Regina Miracle International (Holdings)'s Debt?

The chart below, which you can click on for greater detail, shows that Regina Miracle International (Holdings) had HK$4.29b in debt in September 2021; about the same as the year before. However, it also had HK$698.7m in cash, and so its net debt is HK$3.59b.

How Healthy Is Regina Miracle International (Holdings)'s Balance Sheet?

According to the last reported balance sheet, Regina Miracle International (Holdings) had liabilities of HK$2.11b due within 12 months, and liabilities of HK$3.87b due beyond 12 months. Offsetting this, it had HK$698.7m in cash and HK$1.51b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$3.77b.

This deficit is considerable relative to its market capitalization of HK$5.69b, so it does suggest shareholders should keep an eye on Regina Miracle International (Holdings)'s use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Regina Miracle International (Holdings)'s debt is 3.4 times its EBITDA, and its EBIT cover its interest expense 4.9 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Pleasingly, Regina Miracle International (Holdings) is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 124% gain in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Regina Miracle International (Holdings)'s ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Regina Miracle International (Holdings) burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Regina Miracle International (Holdings)'s conversion of EBIT to free cash flow and net debt to EBITDA definitely weigh on it, in our esteem. But its EBIT growth rate tells a very different story, and suggests some resilience. Taking the abovementioned factors together we do think Regina Miracle International (Holdings)'s debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 2 warning signs for Regina Miracle International (Holdings) you should be aware of, and 1 of them doesn't sit too well with us.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.