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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Ying Kee Tea House Group Limited (HKG:8241) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest 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 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$83.6m of debt at September 2023, down from HK$88.7m a year prior. Net debt is about the same, since the it doesn't have much cash.

A Look At Ying Kee Tea House Group's Liabilities

According to the last reported balance sheet, Ying Kee Tea House Group had liabilities of HK$20.5m due within 12 months, and liabilities of HK$72.3m due beyond 12 months. On the other hand, it had cash of HK$1.06m and HK$619.0k worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$91.1m.

Given this deficit is actually higher than the company's market capitalization of HK$73.4m, 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. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. 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's revenue was pretty flat, and it made a negative EBIT. While that's not too bad, we'd prefer see growth.

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$4.0m. 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. For example, we would not want to see a repeat of last year's loss of HK$9.3m. In the meantime, we consider the stock to be risky. 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. These risks can be hard to spot. Every company has them, and we've spotted 4 warning signs for Ying Kee Tea House Group (of which 2 are a bit unpleasant!) you should know about.

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.