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

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.' 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. Importantly, Royal Catering Group Holdings Company Limited (HKG:8300) does carry debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Royal Catering Group Holdings

What Is Royal Catering Group Holdings's Net Debt?

As you can see below, Royal Catering Group Holdings had HK$14.9m of debt at March 2022, down from HK$15.5m a year prior. But on the other hand it also has HK$63.9m in cash, leading to a HK$49.1m net cash position.

How Healthy Is Royal Catering Group Holdings' Balance Sheet?

The latest balance sheet data shows that Royal Catering Group Holdings had liabilities of HK$29.6m due within a year, and liabilities of HK$1.74m falling due after that. Offsetting this, it had HK$63.9m in cash and HK$2.12m in receivables that were due within 12 months. So it actually has HK$34.8m more liquid assets than total liabilities.

This luscious liquidity implies that Royal Catering Group Holdings' balance sheet is sturdy like a giant sequoia tree. Having regard to this fact, we think its balance sheet is as strong as an ox. 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 if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Over 12 months, Royal Catering Group Holdings made a loss at the EBIT level, and saw its revenue drop to HK$36m, which is a fall of 15%. We would much prefer see growth.

So How Risky Is Royal Catering Group Holdings?

Statistically speaking companies that lose money are riskier than those that make money. And in the last year Royal Catering Group Holdings had an earnings before interest and tax (EBIT) loss, truth be told. Indeed, in that time it burnt through HK$8.1m of cash and made a loss of HK$10m. However, it has net cash of HK$49.1m, so it has a bit of time before it will need more capital. Even though its balance sheet seems sufficiently liquid, debt always makes us a little nervous if a company doesn't produce free cash flow regularly. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Royal Catering Group Holdings is showing 3 warning signs in our investment analysis , and 2 of those are a bit concerning...

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.