Is Lotus Horizon Holdings (HKG:6063) Using Too Much Debt?

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.' 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. Importantly, Lotus Horizon Holdings Limited (HKG:6063) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Lotus Horizon Holdings

What Is Lotus Horizon Holdings's Debt?

You can click the graphic below for the historical numbers, but it shows that Lotus Horizon Holdings had HK$20.8m of debt in September 2020, down from HK$33.0m, one year before. But it also has HK$66.0m in cash to offset that, meaning it has HK$45.3m net cash.

A Look At Lotus Horizon Holdings' Liabilities

Zooming in on the latest balance sheet data, we can see that Lotus Horizon Holdings had liabilities of HK$48.1m due within 12 months and liabilities of HK$9.01m due beyond that. On the other hand, it had cash of HK$66.0m and HK$109.0m worth of receivables due within a year. So it actually has HK$117.9m more liquid assets than total liabilities.

This surplus strongly suggests that Lotus Horizon Holdings has a rock-solid balance sheet (and the debt is of no concern whatsoever). On this view, lenders should feel as safe as the beloved of a black-belt karate master. Succinctly put, Lotus Horizon Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact Lotus Horizon Holdings's saving grace is its low debt levels, because its EBIT has tanked 36% in the last twelve months. 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 you can't view debt in total isolation; since Lotus Horizon Holdings will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Lotus Horizon Holdings may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. In the last three years, Lotus Horizon Holdings created free cash flow amounting to 5.7% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Lotus Horizon Holdings has net cash of HK$45.3m, as well as more liquid assets than liabilities. So we don't have any problem with Lotus Horizon Holdings's use of debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 5 warning signs for Lotus Horizon Holdings that you should be aware of before investing here.

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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