Is Royal Catering Group Holdings (HKG:8300) Using Debt Sensibly?

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Royal Catering Group Holdings Company Limited (HKG:8300) does use debt in its business. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Royal Catering Group Holdings

What Is Royal Catering Group Holdings's Debt?

The image below, which you can click on for greater detail, shows that at March 2021 Royal Catering Group Holdings had debt of HK$15.5m, up from HK$1.93m in one year. But it also has HK$49.7m in cash to offset that, meaning it has HK$34.2m net cash.

A Look At Royal Catering Group Holdings' Liabilities

We can see from the most recent balance sheet that Royal Catering Group Holdings had liabilities of HK$35.8m falling due within a year, and liabilities of HK$913.0k due beyond that. Offsetting this, it had HK$49.7m in cash and HK$1.60m in receivables that were due within 12 months. So it can boast HK$14.6m more liquid assets than total liabilities.

This surplus suggests that Royal Catering Group Holdings has a conservative balance sheet, and could probably eliminate its debt without much difficulty. 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 you can't view debt in total isolation; since Royal Catering Group Holdings will need earnings to service that debt. 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 38%, to HK$43m. That makes us nervous, to say the least.

So How Risky Is Royal Catering Group Holdings?

While Royal Catering Group Holdings lost money on an earnings before interest and tax (EBIT) level, it actually generated positive free cash flow HK$1.6m. So taking that on face value, and considering the net cash situation, we don't think that the stock is too risky in the near term. We'll feel more comfortable with the stock once EBIT is positive, given the lacklustre revenue growth. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Royal Catering Group Holdings (of which 1 doesn't sit too well with us!) you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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