These 4 Measures Indicate That Lai Si Enterprise Holding (HKG:2266) Is Using Debt Reasonably Well

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 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. We can see that Lai Si Enterprise Holding Limited (HKG:2266) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, plenty of companies use debt to fund growth, without any negative consequences. 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 Lai Si Enterprise Holding

What Is Lai Si Enterprise Holding's Debt?

You can click the graphic below for the historical numbers, but it shows that Lai Si Enterprise Holding had MO$31.0m of debt in December 2022, down from MO$47.8m, one year before. However, it does have MO$22.4m in cash offsetting this, leading to net debt of about MO$8.66m.

A Look At Lai Si Enterprise Holding's Liabilities

Zooming in on the latest balance sheet data, we can see that Lai Si Enterprise Holding had liabilities of MO$85.0m due within 12 months and liabilities of MO$3.66m due beyond that. Offsetting these obligations, it had cash of MO$22.4m as well as receivables valued at MO$56.6m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by MO$9.62m.

Since publicly traded Lai Si Enterprise Holding shares are worth a total of MO$133.9m, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

With net debt sitting at just 0.77 times EBITDA, Lai Si Enterprise Holding is arguably pretty conservatively geared. And this view is supported by the solid interest coverage, with EBIT coming in at 8.1 times the interest expense over the last year. It was also good to see that despite losing money on the EBIT line last year, Lai Si Enterprise Holding turned things around in the last 12 months, delivering and EBIT of MO$10m. There's no doubt that we learn most about debt from the balance sheet. But it is Lai Si Enterprise Holding'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Happily for any shareholders, Lai Si Enterprise Holding actually produced more free cash flow than EBIT over the last year. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

Happily, Lai Si Enterprise Holding's impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. And the good news does not stop there, as its net debt to EBITDA also supports that impression! Looking at the bigger picture, we think Lai Si Enterprise Holding's use of debt seems quite reasonable and we're not concerned about it. After all, sensible leverage can boost returns on equity. 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Lai Si Enterprise Holding (of which 1 doesn't sit too well with us!) you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.