Lonking Holdings (HKG:3339) Seems To Use Debt Rather Sparingly

Warren Buffett famously said, '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. Importantly, Lonking Holdings Limited (HKG:3339) does carry debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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.

Check out our latest analysis for Lonking Holdings

What Is Lonking Holdings's Debt?

The image below, which you can click on for greater detail, shows that Lonking Holdings had debt of CN¥656.9m at the end of June 2021, a reduction from CN¥719.8m over a year. But it also has CN¥5.18b in cash to offset that, meaning it has CN¥4.52b net cash.

How Healthy Is Lonking Holdings' Balance Sheet?

The latest balance sheet data shows that Lonking Holdings had liabilities of CN¥7.94b due within a year, and liabilities of CN¥735.5m falling due after that. On the other hand, it had cash of CN¥5.18b and CN¥4.04b worth of receivables due within a year. So it can boast CN¥545.2m more liquid assets than total liabilities.

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

The good news is that Lonking Holdings has increased its EBIT by 6.2% over twelve months, which should ease any concerns about debt repayment. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Lonking Holdings can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Lonking Holdings has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Lonking Holdings produced sturdy free cash flow equating to 68% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While it is always sensible to investigate a company's debt, in this case Lonking Holdings has CN¥4.52b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥773m, being 68% of its EBIT. So we don't think Lonking Holdings's use of debt is risky. 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. To that end, you should learn about the 3 warning signs we've spotted with Lonking Holdings (including 2 which can't be ignored) .

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.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.