Is Luen Wong Group Holdings (HKG:8217) Using Too Much Debt?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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 the real question is whether this debt is making the company risky.

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. 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, 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Luen Wong Group Holdings

How Much Debt Does Luen Wong Group Holdings Carry?

The image below, which you can click on for greater detail, shows that Luen Wong Group Holdings had debt of HK$132.9m at the end of September 2020, a reduction from HK$141.4m over a year. However, it also had HK$21.6m in cash, and so its net debt is HK$111.2m.

How Healthy Is Luen Wong Group Holdings's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Luen Wong Group Holdings had liabilities of HK$183.9m due within 12 months and liabilities of HK$2.73m due beyond that. Offsetting this, it had HK$21.6m in cash and HK$167.2m in receivables that were due within 12 months. So its total liabilities are just about perfectly matched by its shorter-term, liquid assets.

This surplus suggests that Luen Wong Group Holdings has a conservative balance sheet, and could probably eliminate its debt without much difficulty. When analysing debt levels, the balance sheet is the obvious place to start. But it is Luen Wong Group Holdings's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Over 12 months, Luen Wong Group Holdings made a loss at the EBIT level, and saw its revenue drop to HK$272m, which is a fall of 26%. To be frank that doesn't bode well.

Caveat Emptor

While Luen Wong Group Holdings's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost a very considerable HK$27m at the EBIT level. On a more positive note, the company does have liquid assets, so it has a bit of time to improve its operations before the debt becomes an acute problem. But we'd want to see some positive free cashflow before spending much time on trying to understand the stock. This one is a bit too risky for our liking. 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. To that end, you should learn about the 4 warning signs we've spotted with Luen Wong Group Holdings (including 2 which is are significant) .

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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