Howard Marks put it well when he said that, rather than worrying about stock price volatility, “The possibility of permanent loss is the risk I worry about … and every investor practice that I know is worried “. So it can be obvious that you need to consider debt, when you think about how risky a given stock is because too much debt can sink a business. Like many other companies Royal Orchid Limited Hotels (NSE: ROHLTD) uses debt. But the most important question is: what risk does this debt create?
What risk does debt entail?
Generally speaking, debt only becomes a real problem when a company cannot repay it easily, either by raising capital or with its own cash flow. In the worst case scenario, a business can go bankrupt if it cannot pay its creditors. However, a more common (but still costly) situation is where a company has to dilute its shareholders at a cheap share price just to get its debt under control. By replacing dilution, however, debt can be a very good tool for companies that need capital to invest in growth at high rates of return. When we look at debt levels, we first look at cash and debt levels, together.
See our latest review for Royal Orchid hotels
What is the debt of Royal Orchid hotels?
As you can see below, at the end of September 2021, Royal Orchid Hotels had a debt of 1.09 billion yen, up from 897.2 million yen a year ago. Click on the image for more details. On the other hand, it has 443.5 million euros in cash, resulting in net debt of around 644.4 million euros.
How healthy is the balance sheet for Royal Orchid hotels?
Zooming in on the latest balance sheet data, we can see that Royal Orchid Hotels had a liability of 1.11 billion yen owed within 12 months and a liability of 1.42 billion yen owed beyond that. In return, it had 443.5 million in cash and 144.3 million in receivables due within 12 months. Its liabilities therefore total 1.94 billion yen more than the combination of its cash and short-term receivables.
This deficit is sizable compared to its market capitalization of 2.38 billion yen, so he suggests shareholders keep an eye on Royal Orchid Hotels’ use of debt. This suggests that shareholders would be greatly diluted if the company needed to consolidate its balance sheet quickly. There is no doubt that we learn the most about debt from the balance sheet. But you can’t look at debt in isolation; since Royal Orchid Hotels will need revenue to repay this debt. So, when considering debt, it is really worth looking at the profit trend. Click here for an interactive snapshot.
Over the past year, Royal Orchid Hotels has incurred a loss before interest and taxes and has actually reduced its revenue by 15%, to 1.1 billion yen. This is not what we hope to see.
Not only has Royal Orchid Hotels revenue declined over the past twelve months, it has also produced negative earnings before interest and taxes (EBIT). Indeed, it lost 136 million euros at the EBIT level. Considering that besides the liabilities mentioned above, we are not convinced that the company should use so much debt. Quite frankly, we think the record is far from up to par, although it could improve over time. For example, we wouldn’t want to see a repeat of last year’s 190 million yen loss. So, to be frank, we think it’s risky. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risks lie on the balance sheet – far from it. For example, we discovered 2 warning signs for Royal Orchid hotels (1 is potentially serious!) Which you should be aware of before investing here.
If you want to invest in companies that can generate profits without the burden of debt, check out this free list of growing companies that have net cash on the balance sheet.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only 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 into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.