Does Tak Lee Machinery Holdings (HKG:2102) Have A Healthy Balance Sheet?

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Tak Lee Machinery Holdings Limited (HKG:2102) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Tak Lee Machinery Holdings

What Is Tak Lee Machinery Holdings's Net Debt?

The image below, which you can click on for greater detail, shows that at January 2024 Tak Lee Machinery Holdings had debt of HK$19.4m, up from HK$10.9m in one year. But it also has HK$45.3m in cash to offset that, meaning it has HK$25.9m net cash.

A Look At Tak Lee Machinery Holdings' Liabilities

We can see from the most recent balance sheet that Tak Lee Machinery Holdings had liabilities of HK$41.8m falling due within a year, and liabilities of HK$22.8m due beyond that. Offsetting these obligations, it had cash of HK$45.3m as well as receivables valued at HK$97.3m due within 12 months. So it can boast HK$78.1m more liquid assets than total liabilities.

This surplus strongly suggests that Tak Lee Machinery Holdings has a rock-solid balance sheet (and the debt is of no concern whatsoever). Having regard to this fact, we think its balance sheet is as strong as an ox. Succinctly put, Tak Lee Machinery Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Tak Lee Machinery Holdings if management cannot prevent a repeat of the 65% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But it is Tak Lee Machinery Holdings's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Tak Lee Machinery Holdings 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. Over the last three years, Tak Lee Machinery Holdings actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While it is always sensible to investigate a company's debt, in this case Tak Lee Machinery Holdings has HK$25.9m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 123% of that EBIT to free cash flow, bringing in -HK$4.1m. So is Tak Lee Machinery Holdings's debt a risk? It doesn't seem so to us. 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. We've identified 4 warning signs with Tak Lee Machinery Holdings (at least 1 which is a bit concerning) , and understanding them should be part of your investment process.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.