Health Check: How Prudently Does Ying Kee Tea House Group (HKG:8241) Use Debt?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 note that Ying Kee Tea House Group Limited (HKG:8241) does have debt on its balance sheet. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Ying Kee Tea House Group

What Is Ying Kee Tea House Group's Debt?

As you can see below, Ying Kee Tea House Group had HK$86.9m of debt at March 2023, down from HK$94.7m a year prior. On the flip side, it has HK$2.28m in cash leading to net debt of about HK$84.6m.

How Strong Is Ying Kee Tea House Group's Balance Sheet?

According to the last reported balance sheet, Ying Kee Tea House Group had liabilities of HK$18.3m due within 12 months, and liabilities of HK$71.5m due beyond 12 months. Offsetting this, it had HK$2.28m in cash and HK$644.0k in receivables that were due within 12 months. So its liabilities total HK$86.9m more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of HK$77.4m, we think shareholders really should watch Ying Kee Tea House Group's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Ying Kee Tea House Group'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 Ying Kee Tea House Group wasn't profitable at an EBIT level, but managed to grow its revenue by 4.4%, to HK$37m. We usually like to see faster growth from unprofitable companies, but each to their own.

Caveat Emptor

Over the last twelve months Ying Kee Tea House Group produced an earnings before interest and tax (EBIT) loss. To be specific the EBIT loss came in at HK$3.5m. When we look at that alongside the significant liabilities, we're not particularly confident about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. It's fair to say the loss of HK$7.9m didn't encourage us either; we'd like to see a profit. In the meantime, we consider the stock to be 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. For instance, we've identified 3 warning signs for Ying Kee Tea House Group (2 are concerning) you should be aware of.

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.