Is Royal Catering Group Holdings (HKG:8300) Using Debt In A Risky Way?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Royal Catering Group Holdings Company Limited (HKG:8300) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Royal Catering Group Holdings

What Is Royal Catering Group Holdings's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2021 Royal Catering Group Holdings had HK$15.5m of debt, an increase on none, over one year. However, it does have HK$75.2m in cash offsetting this, leading to net cash of HK$59.7m.

How Healthy Is Royal Catering Group Holdings' Balance Sheet?

According to the last reported balance sheet, Royal Catering Group Holdings had liabilities of HK$32.0m due within 12 months, and liabilities of HK$1.39m due beyond 12 months. Offsetting this, it had HK$75.2m in cash and HK$1.30m in receivables that were due within 12 months. So it actually has HK$43.1m more liquid assets than total liabilities.

This surplus liquidity suggests that Royal Catering Group Holdings' balance sheet could take a hit just as well as Homer Simpson's head can take a punch. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Succinctly put, Royal Catering Group Holdings boasts net cash, so it's fair to say it does not have a heavy debt load! There's no doubt that we learn most about debt from the balance sheet. But it is Royal Catering Group Holdings'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 Royal Catering Group Holdings had a loss before interest and tax, and actually shrunk its revenue by 6.7%, to HK$44m. We would much prefer see growth.

So How Risky Is Royal Catering Group Holdings?

By their very nature companies that are losing money are more risky than those with a long history of profitability. And we do note that Royal Catering Group Holdings had an earnings before interest and tax (EBIT) loss, over the last year. And over the same period it saw negative free cash outflow of HK$1.3m and booked a HK$3.6m accounting loss. However, it has net cash of HK$59.7m, so it has a bit of time before it will need more capital. Overall, its balance sheet doesn't seem overly risky, at the moment, but we're always cautious until we see the positive free cash flow. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 3 warning signs for Royal Catering Group Holdings you should be aware of, and 1 of them doesn't sit too well with us.

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.