These 4 Measures Indicate That L.K. Technology Holdings (HKG:558) Is Using Debt Extensively

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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 can see that L.K. Technology Holdings Limited (HKG:558) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for L.K. Technology Holdings

How Much Debt Does L.K. Technology Holdings Carry?

You can click the graphic below for the historical numbers, but it shows that as of March 2023 L.K. Technology Holdings had HK$1.64b of debt, an increase on HK$1.09b, over one year. However, it also had HK$605.4m in cash, and so its net debt is HK$1.04b.

A Look At L.K. Technology Holdings' Liabilities

Zooming in on the latest balance sheet data, we can see that L.K. Technology Holdings had liabilities of HK$4.27b due within 12 months and liabilities of HK$414.7m due beyond that. On the other hand, it had cash of HK$605.4m and HK$2.87b worth of receivables due within a year. So its liabilities total HK$1.21b more than the combination of its cash and short-term receivables.

Since publicly traded L.K. Technology Holdings shares are worth a total of HK$10.4b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

L.K. Technology Holdings has a low net debt to EBITDA ratio of only 1.2. And its EBIT easily covers its interest expense, being 15.7 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. On the other hand, L.K. Technology Holdings's EBIT dived 10%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. When analysing debt levels, the balance sheet is the obvious place to start. 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, L.K. Technology Holdings created free cash flow amounting to 4.9% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

Neither L.K. Technology Holdings's ability to convert EBIT to free cash flow nor its EBIT growth rate gave us confidence in its ability to take on more debt. But its interest cover tells a very different story, and suggests some resilience. We think that L.K. Technology Holdings's debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of L.K. Technology Holdings's earnings per share history for free.

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.