Is Royal Group Holdings International (HKG:8300) Using Too Much Debt?

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.' 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. Importantly, Royal Group Holdings International Company Limited (HKG:8300) does carry debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Royal Group Holdings International

What Is Royal Group Holdings International's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2022 Royal Group Holdings International had HK$26.8m of debt, an increase on HK$14.9m, over one year. But on the other hand it also has HK$47.6m in cash, leading to a HK$20.8m net cash position.

How Healthy Is Royal Group Holdings International's Balance Sheet?

According to the last reported balance sheet, Royal Group Holdings International had liabilities of HK$28.7m due within 12 months, and liabilities of HK$7.53m due beyond 12 months. Offsetting this, it had HK$47.6m in cash and HK$2.45m in receivables that were due within 12 months. So it actually has HK$13.9m more liquid assets than total liabilities.

This excess liquidity suggests that Royal Group Holdings International is taking a careful approach to debt. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that Royal Group Holdings International has more cash than debt is arguably a good indication that it can manage its debt safely. There's no doubt that we learn most about debt from the balance sheet. But it is Royal Group Holdings International'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.

Over 12 months, Royal Group Holdings International made a loss at the EBIT level, and saw its revenue drop to HK$25m, which is a fall of 39%. That makes us nervous, to say the least.

So How Risky Is Royal Group Holdings International?

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 Group Holdings International had an earnings before interest and tax (EBIT) loss, over the last year. Indeed, in that time it burnt through HK$23m of cash and made a loss of HK$20m. But at least it has HK$20.8m on the balance sheet to spend on growth, near-term. 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. For example Royal Group Holdings International has 4 warning signs (and 2 which make us uncomfortable) we think you should know about.

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.