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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 Rykadan Capital Limited (HKG:2288) makes use of debt. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
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. 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 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 Rykadan Capital
What Is Rykadan Capital's Net Debt?
The image below, which you can click on for greater detail, shows that Rykadan Capital had debt of HK$416.7m at the end of March 2019, a reduction from HK$908.1m over a year. However, it does have HK$439.0m in cash offsetting this, leading to net cash of HK$22.3m.
A Look At Rykadan Capital's Liabilities
We can see from the most recent balance sheet that Rykadan Capital had liabilities of HK$541.4m falling due within a year, and liabilities of HK$13.4m due beyond that. On the other hand, it had cash of HK$439.0m and HK$109.6m worth of receivables due within a year. So its total liabilities are just about perfectly matched by its shorter-term, liquid assets.
Having regard to Rykadan Capital's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the HK$319.9m company is struggling for cash, we still think it's worth monitoring its balance sheet. While it does have liabilities worth noting, Rykadan Capital also has more cash than debt, so we're pretty confident it can manage its debt safely.
It was also good to see that despite losing money on the EBIT line last year, Rykadan Capital turned things around in the last 12 months, delivering and EBIT of HK$305m. There's no doubt that we learn most about debt from the balance sheet. But it is Rykadan Capital'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.