Is Lai Si Enterprise Holding (HKG:2266) A Risky Investment?

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Lai Si Enterprise Holding Limited (HKG:2266) does have debt on its balance sheet. But is this debt a concern to shareholders?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Our analysis indicates that 2266 is potentially overvalued!

What Is Lai Si Enterprise Holding's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2022 Lai Si Enterprise Holding had debt of MO$56.6m, up from MO$50.2m in one year. However, because it has a cash reserve of MO$2.34m, its net debt is less, at about MO$54.3m.

How Healthy Is Lai Si Enterprise Holding's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Lai Si Enterprise Holding had liabilities of MO$103.5m due within 12 months and liabilities of MO$2.84m due beyond that. On the other hand, it had cash of MO$2.34m and MO$77.9m worth of receivables due within a year. So it has liabilities totalling MO$26.1m more than its cash and near-term receivables, combined.

Of course, Lai Si Enterprise Holding has a market capitalization of MO$288.4m, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Lai Si Enterprise Holding will need earnings to service that debt. 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.

Over 12 months, Lai Si Enterprise Holding made a loss at the EBIT level, and saw its revenue drop to MO$140m, which is a fall of 8.9%. We would much prefer see growth.

Caveat Emptor

Over the last twelve months Lai Si Enterprise Holding produced an earnings before interest and tax (EBIT) loss. Indeed, it lost MO$3.6m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. We would feel better if it turned its trailing twelve month loss of MO$3.9m into a profit. So we do think this stock is quite risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example Lai Si Enterprise Holding has 3 warning signs (and 2 which make us uncomfortable) we think you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.