Would Luen Wong Group Holdings (HKG:8217) Be Better Off With Less Debt?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Luen Wong Group Holdings Limited (HKG:8217) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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 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.

See our latest analysis for Luen Wong Group Holdings

How Much Debt Does Luen Wong Group Holdings Carry?

The chart below, which you can click on for greater detail, shows that Luen Wong Group Holdings had HK$107.2m in debt in September 2021; about the same as the year before. However, it also had HK$46.7m in cash, and so its net debt is HK$60.5m.

How Healthy Is Luen Wong Group Holdings' Balance Sheet?

The latest balance sheet data shows that Luen Wong Group Holdings had liabilities of HK$126.6m due within a year, and liabilities of HK$12.1m falling due after that. Offsetting this, it had HK$46.7m in cash and HK$114.5m in receivables that were due within 12 months. So it actually has HK$22.5m more liquid assets than total liabilities.

This surplus strongly suggests that Luen Wong Group 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. There's no doubt that we learn most about debt from the balance sheet. But it is Luen Wong Group 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.

Over 12 months, Luen Wong Group Holdings made a loss at the EBIT level, and saw its revenue drop to HK$97m, which is a fall of 60%. 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). Indeed, it lost a very considerable HK$5.8m 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 a profit would do more to inspire us to research the business more closely. This one is a bit too risky for our liking. 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 Luen Wong Group Holdings has 4 warning signs (and 3 which are concerning) we think you should know about.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.