Is Luen Wong Group Holdings (HKG:8217) A Risky Investment?

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.' 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 Luen Wong Group Holdings Limited (HKG:8217) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Luen Wong Group Holdings

What Is Luen Wong Group Holdings's Net Debt?

The chart below, which you can click on for greater detail, shows that Luen Wong Group Holdings had HK$132.9m in debt in September 2020; about the same as the year before. However, because it has a cash reserve of HK$21.6m, its net debt is less, at about HK$111.2m.

A Look At Luen Wong Group Holdings' Liabilities

The latest balance sheet data shows that Luen Wong Group Holdings had liabilities of HK$183.9m due within a year, and liabilities of HK$2.73m falling due after that. Offsetting this, it had HK$21.6m in cash and HK$167.2m in receivables that were due within 12 months. So these liquid assets roughly match the total liabilities.

This short term liquidity is a sign that Luen Wong Group Holdings could probably pay off its debt with ease, as its balance sheet is far from stretched. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Luen Wong Group 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.

In the last year Luen Wong Group Holdings had a loss before interest and tax, and actually shrunk its revenue by 28%, to HK$240m. To be frank that doesn't bode well.

Caveat Emptor

Not only did Luen Wong Group Holdings's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Its EBIT loss was a whopping HK$21m. Looking on the brighter side, the business has adequate liquid assets, which give it time to grow and develop before its debt becomes a near-term issue. But we'd want to see some positive free cashflow before spending much time on trying to understand the stock. So it seems too risky for our taste. 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 instance, we've identified 4 warning signs for Luen Wong Group Holdings (2 don't sit too well with us) you should be aware of.

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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This article by Simply Wall St is general in nature. 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.
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