Is L.K. Technology Holdings (HKG:558) Using Too Much Debt?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 note that L.K. Technology Holdings Limited (HKG:558) does have debt on its balance sheet. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. 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 L.K. Technology Holdings

What Is L.K. Technology Holdings's Debt?

As you can see below, L.K. Technology Holdings had HK$855.0m of debt at September 2021, down from HK$1.43b a year prior. But it also has HK$961.4m in cash to offset that, meaning it has HK$106.4m net cash.

A Look At L.K. Technology Holdings' Liabilities

We can see from the most recent balance sheet that L.K. Technology Holdings had liabilities of HK$3.03b falling due within a year, and liabilities of HK$330.3m due beyond that. On the other hand, it had cash of HK$961.4m and HK$1.95b worth of receivables due within a year. So its liabilities total HK$449.3m more than the combination of its cash and short-term receivables.

Given L.K. Technology Holdings has a market capitalization of HK$18.5b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, L.K. Technology Holdings also has more cash than debt, so we're pretty confident it can manage its debt safely.

Even more impressive was the fact that L.K. Technology Holdings grew its EBIT by 228% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if L.K. Technology Holdings can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While L.K. Technology 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, L.K. Technology Holdings produced sturdy free cash flow equating to 60% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that L.K. Technology Holdings has HK$106.4m in net cash. And it impressed us with its EBIT growth of 228% over the last year. So is L.K. Technology 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. For example - L.K. Technology Holdings has 2 warning signs we think you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.