Royal Orchid Hotels (NSE:ROHLTD) Seems To Use Debt Quite 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.' 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. As with many other companies Royal Orchid Hotels Limited (NSE:ROHLTD) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. 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 Orchid Hotels

How Much Debt Does Royal Orchid Hotels Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Royal Orchid Hotels had ₹835.1m of debt, an increase on ₹707.0m, over one year. However, it also had ₹449.6m in cash, and so its net debt is ₹385.6m.

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 ₹855.7m due within 12 months and liabilities of ₹1.94b due beyond that. Offsetting these obligations, it had cash of ₹449.6m as well as receivables valued at ₹375.3m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹1.97b.

While this might seem like a lot, it is not so bad since Royal Orchid Hotels has a market capitalization of ₹9.78b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Looking at its net debt to EBITDA of 0.52 and interest cover of 4.9 times, it seems to us that Royal Orchid Hotels is probably using debt in a pretty reasonable way. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. Unfortunately, Royal Orchid Hotels saw its EBIT slide 3.5% in the last twelve months. If earnings continue on that decline then managing that debt will be difficult like delivering hot soup on a unicycle. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Royal Orchid Hotels'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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the most recent three years, Royal Orchid Hotels recorded free cash flow worth 53% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

When it comes to the balance sheet, the standout positive for Royal Orchid Hotels was the fact that it seems able handle its debt, based on its EBITDA, confidently. However, our other observations weren't so heartening. For instance it seems like it has to struggle a bit to grow its EBIT. When we consider all the elements mentioned above, it seems to us that Royal Orchid Hotels is managing its debt quite well. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 1 warning sign we've spotted with Royal Orchid Hotels .

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.