Is Royal Orchid Hotels (NSE:ROHLTD) Using Debt Sensibly?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Royal Orchid Hotels Limited (NSE:ROHLTD) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Royal Orchid Hotels

How Much Debt Does Royal Orchid Hotels Carry?

As you can see below, Royal Orchid Hotels had ₹897.2m of debt, at September 2020, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has ₹350.3m in cash leading to net debt of about ₹546.9m.

How Healthy Is Royal Orchid Hotels' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Royal Orchid Hotels had liabilities of ₹946.3m due within 12 months and liabilities of ₹1.39b due beyond that. On the other hand, it had cash of ₹350.3m and ₹144.4m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹1.85b.

This deficit is considerable relative to its market capitalization of ₹2.08b, so it does suggest shareholders should keep an eye on Royal Orchid Hotels' use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. 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 Royal Orchid Hotels 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 Orchid Hotels had a loss before interest and tax, and actually shrunk its revenue by 38%, to ₹1.3b. That makes us nervous, to say the least.

Caveat Emptor

Not only did Royal Orchid Hotels's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost ₹143m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. For example, we would not want to see a repeat of last year's loss of ₹209m. So to be blunt we do think it is risky. 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 instance, we've identified 3 warning signs for Royal Orchid Hotels (2 are significant) you should be aware of.

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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