Is Café de Coral Holdings (HKG:341) A Risky Investment?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 can see that Café de Coral Holdings Limited (HKG:341) does use debt in its business. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Café de Coral Holdings

How Much Debt Does Café de Coral Holdings Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2021 Café de Coral Holdings had HK$1.13b of debt, an increase on HK$679.3m, over one year. However, its balance sheet shows it holds HK$1.95b in cash, so it actually has HK$815.7m net cash.

How Strong Is Café de Coral Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Café de Coral Holdings had liabilities of HK$1.73b due within 12 months and liabilities of HK$2.37b due beyond that. Offsetting these obligations, it had cash of HK$1.95b as well as receivables valued at HK$117.4m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$2.05b.

This deficit isn't so bad because Café de Coral Holdings is worth HK$6.20b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. 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.

Notably, Café de Coral Holdings made a loss at the EBIT level, last year, but improved that to positive EBIT of HK$161m in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. 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 want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 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 year, 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$815.7m. The cherry on top was that in converted 809% of that EBIT to free cash flow, bringing in HK$1.3b. So we don't have any problem with Café de Coral Holdings's use of debt. 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. We've identified 3 warning signs with Café de Coral Holdings , and understanding them should be part of your investment process.

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.