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.' 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. We can see that Luen Wong Group Holdings Limited (HKG:8217) does use debt in its business. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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. 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

How Much Debt Does Luen Wong Group Holdings Carry?

You can click the graphic below for the historical numbers, but it shows that Luen Wong Group Holdings had HK$55.0m of debt in March 2022, down from HK$107.0m, one year before. However, it does have HK$44.7m in cash offsetting this, leading to net debt of about HK$10.3m.

A Look At Luen Wong Group Holdings' Liabilities

Zooming in on the latest balance sheet data, we can see that Luen Wong Group Holdings had liabilities of HK$83.8m due within 12 months and no liabilities due beyond that. On the other hand, it had cash of HK$44.7m and HK$91.7m worth of receivables due within a year. So it can boast HK$52.6m more liquid assets than total liabilities.

This surplus liquidity suggests that Luen Wong Group Holdings' balance sheet could take a hit just as well as Homer Simpson's head can take a punch. Having regard to this fact, we think its balance sheet is as strong as an ox. When analysing debt levels, the balance sheet is the obvious place to start. 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.

Over 12 months, Luen Wong Group Holdings made a loss at the EBIT level, and saw its revenue drop to HK$93m, which is a fall of 45%. 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$21m at the EBIT level. That said, we're impressed with the strong balance sheet liquidity. That should give the business time to grow its cashflow. While the stock is probably a bit risky, there may be an opportunity if the business itself improves, allowing the company to stage a recovery. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 4 warning signs for Luen Wong Group Holdings you should be aware of, and 3 of them are a bit concerning.

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. 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.