Is Ying Kee Tea House Group (HKG:8241) Weighed On By Its Debt Load?

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.' 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 can see that Ying Kee Tea House Group Limited (HKG:8241) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. 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, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Ying Kee Tea House Group

What Is Ying Kee Tea House Group's Debt?

The chart below, which you can click on for greater detail, shows that Ying Kee Tea House Group had HK$88.7m in debt in September 2021; about the same as the year before. On the flip side, it has HK$2.12m in cash leading to net debt of about HK$86.6m.

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

Zooming in on the latest balance sheet data, we can see that Ying Kee Tea House Group had liabilities of HK$17.0m due within 12 months and liabilities of HK$79.8m due beyond that. Offsetting these obligations, it had cash of HK$2.12m as well as receivables valued at HK$4.15m due within 12 months. So its liabilities total HK$90.6m more than the combination of its cash and short-term receivables.

When you consider that this deficiency exceeds the company's HK$76.3m market capitalization, you might well be inclined to review the balance sheet intently. 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.

Over 12 months, Ying Kee Tea House Group reported revenue of HK$37m, which is a gain of 8.1%, although it did not report any earnings before interest and tax. We usually like to see faster growth from unprofitable companies, but each to their own.

Caveat Emptor

Importantly, Ying Kee Tea House Group had an earnings before interest and tax (EBIT) loss over the last year. To be specific the EBIT loss came in at HK$4.8m. 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$8.3m. In the meantime, we consider the stock to be risky. The balance sheet is clearly the area to focus on when you are analysing debt. 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.

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.

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