Is Leo Group (SZSE:002131) Using Too Much Debt?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. We can see that Leo Group Co., Ltd. (SZSE:002131) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Leo Group

How Much Debt Does Leo Group Carry?

The image below, which you can click on for greater detail, shows that at September 2024 Leo Group had debt of CN¥3.63b, up from CN¥3.07b in one year. However, its balance sheet shows it holds CN¥6.67b in cash, so it actually has CN¥3.03b net cash.

A Look At Leo Group's Liabilities

According to the last reported balance sheet, Leo Group had liabilities of CN¥7.39b due within 12 months, and liabilities of CN¥2.59b due beyond 12 months. Offsetting this, it had CN¥6.67b in cash and CN¥6.84b in receivables that were due within 12 months. So it actually has CN¥3.53b more liquid assets than total liabilities.

This short term liquidity is a sign that Leo Group could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Leo Group boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact Leo Group's saving grace is its low debt levels, because its EBIT has tanked 75% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Leo Group 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Leo Group may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, Leo Group burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

While it is always sensible to investigate a company's debt, in this case Leo Group has CN¥3.03b in net cash and a decent-looking balance sheet. So although we see some areas for improvement, we're not too worried about Leo Group's balance sheet. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 3 warning signs for Leo Group 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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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.