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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Royal Orchid Hotels Limited (NSE:ROHLTD) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Royal Orchid Hotels's Net Debt?
The image below, which you can click on for greater detail, shows that at March 2021 Royal Orchid Hotels had debt of ₹1.51b, up from ₹1.42b in one year. On the flip side, it has ₹485.4m in cash leading to net debt of about ₹1.03b.
A Look At Royal Orchid Hotels' Liabilities
We can see from the most recent balance sheet that Royal Orchid Hotels had liabilities of ₹1.01b falling due within a year, and liabilities of ₹1.45b due beyond that. Offsetting this, it had ₹485.4m in cash and ₹111.2m in receivables that were due within 12 months. So it has liabilities totalling ₹1.86b more than its cash and near-term receivables, combined.
This is a mountain of leverage relative to its market capitalization of ₹2.01b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. When analysing debt levels, the balance sheet is the obvious place to start. But it is Royal Orchid Hotels's earnings that will influence how the balance sheet holds up in the future. 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 Orchid Hotels made a loss at the EBIT level, and saw its revenue drop to ₹910m, which is a fall of 43%. That makes us nervous, to say the least.
While Royal Orchid Hotels's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Its EBIT loss was a whopping ₹256m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. We would feel better if it turned its trailing twelve month loss of ₹301m into a profit. So we do think this stock is quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example Royal Orchid Hotels has 3 warning signs (and 1 which is concerning) 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.
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