Here's Why Café de Coral Holdings (HKG:341) Has A Meaningful Debt Burden

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 can see that Café de Coral Holdings Limited (HKG:341) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

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How Much Debt Does Café de Coral Holdings Carry?

The image below, which you can click on for greater detail, shows that Café de Coral Holdings had debt of HK$1.03b at the end of September 2022, a reduction from HK$1.13b over a year. But it also has HK$1.58b in cash to offset that, meaning it has HK$552.3m net cash.

How Strong Is Café de Coral Holdings' Balance Sheet?

The latest balance sheet data shows that Café de Coral Holdings had liabilities of HK$2.46b due within a year, and liabilities of HK$1.86b falling due after that. On the other hand, it had cash of HK$1.58b and HK$124.9m worth of receivables due within a year. So it has liabilities totalling HK$2.61b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Café de Coral Holdings has a market capitalization of HK$6.93b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. While it does have liabilities worth noting, Café de Coral Holdings also has more cash than debt, so we're pretty confident it can manage its debt safely.

Importantly, Café de Coral Holdings's EBIT fell a jaw-dropping 31% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Café de Coral Holdings's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Café de Coral Holdings may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last two years, Café de Coral Holdings actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

While Café de Coral Holdings does have more liabilities than liquid assets, it also has net cash of HK$552.3m. The cherry on top was that in converted 728% of that EBIT to free cash flow, bringing in HK$673m. So although we see some areas for improvement, we're not too worried about Café de Coral Holdings's balance sheet. 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 example, we've discovered 2 warning signs for Café de Coral Holdings that you should be aware of before investing here.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.