Does Lotus Horizon Holdings (HKG:6063) Have A Healthy Balance Sheet?

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Lotus Horizon Holdings Limited (HKG:6063) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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, 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 Lotus Horizon Holdings

How Much Debt Does Lotus Horizon Holdings Carry?

The image below, which you can click on for greater detail, shows that Lotus Horizon Holdings had debt of HK$19.0m at the end of September 2021, a reduction from HK$20.8m over a year. But on the other hand it also has HK$58.5m in cash, leading to a HK$39.5m net cash position.

How Healthy Is Lotus Horizon Holdings' Balance Sheet?

We can see from the most recent balance sheet that Lotus Horizon Holdings had liabilities of HK$49.1m falling due within a year, and liabilities of HK$7.60m due beyond that. Offsetting these obligations, it had cash of HK$58.5m as well as receivables valued at HK$117.8m due within 12 months. So it can boast HK$119.6m more liquid assets than total liabilities.

This surplus liquidity suggests that Lotus Horizon Holdings' balance sheet could take a hit just as well as Homer Simpson's head can take a punch. With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Simply put, the fact that Lotus Horizon Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.

The modesty of its debt load may become crucial for Lotus Horizon Holdings if management cannot prevent a repeat of the 69% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But it is Lotus Horizon Holdings's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Lotus Horizon 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. Over the last three years, Lotus Horizon Holdings reported free cash flow worth 6.7% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing up

While it is always sensible to investigate a company's debt, in this case Lotus Horizon Holdings has HK$39.5m in net cash and a decent-looking balance sheet. So we don't have any problem with Lotus Horizon Holdings's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example Lotus Horizon Holdings has 5 warning signs (and 1 which is a bit concerning) we think you should know about.

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.