Does Rykadan Capital (HKG:2288) Have A Healthy Balance Sheet?

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.' 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 Rykadan Capital Limited (HKG:2288) does use debt in its business. 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. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Rykadan Capital

What Is Rykadan Capital's Net Debt?

As you can see below, Rykadan Capital had HK$339.6m of debt at September 2020, down from HK$402.7m a year prior. However, it does have HK$564.6m in cash offsetting this, leading to net cash of HK$225.0m.

How Strong Is Rykadan Capital's Balance Sheet?

According to the balance sheet data, Rykadan Capital had liabilities of HK$375.0m due within 12 months, but no longer term liabilities. Offsetting this, it had HK$564.6m in cash and HK$183.1m in receivables that were due within 12 months. So it can boast HK$372.8m more liquid assets than total liabilities.

This surplus liquidity suggests that Rykadan Capital's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that Rykadan Capital has more cash than debt is arguably a good indication that it can manage its debt safely. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Rykadan Capital 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, Rykadan Capital made a loss at the EBIT level, and saw its revenue drop to HK$221m, which is a fall of 75%. That makes us nervous, to say the least.

So How Risky Is Rykadan Capital?

Although Rykadan Capital had an earnings before interest and tax (EBIT) loss over the last twelve months, it generated positive free cash flow of HK$37m. 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. There's no doubt the next few years will be crucial to how the business matures. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 1 warning sign with Rykadan Capital , and understanding them should be part of your investment process.

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. 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.
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