Lion Rock Group (HKG:1127) Seems To Use Debt Quite Sensibly

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 can see that Lion Rock Group Limited (HKG:1127) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Lion Rock Group

How Much Debt Does Lion Rock Group Carry?

You can click the graphic below for the historical numbers, but it shows that Lion Rock Group had HK$191.5m of debt in December 2020, down from HK$214.8m, one year before. However, its balance sheet shows it holds HK$502.3m in cash, so it actually has HK$310.9m net cash.

How Strong Is Lion Rock Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Lion Rock Group had liabilities of HK$502.0m due within 12 months and liabilities of HK$87.4m due beyond that. Offsetting this, it had HK$502.3m in cash and HK$436.5m in receivables that were due within 12 months. So it can boast HK$349.5m more liquid assets than total liabilities.

This surplus strongly suggests that Lion Rock Group has a rock-solid balance sheet (and the debt is of no concern whatsoever). Having regard to this fact, we think its balance sheet is as strong as an ox. Succinctly put, Lion Rock Group boasts net cash, so it's fair to say it does not have a heavy debt load!

Importantly, Lion Rock Group's EBIT fell a jaw-dropping 64% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Lion Rock Group'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Lion Rock Group has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the most recent three years, Lion Rock Group recorded free cash flow worth 61% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While it is always sensible to investigate a company's debt, in this case Lion Rock Group has HK$310.9m in net cash and a decent-looking balance sheet. So we are not troubled with Lion Rock Group's debt use. 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 instance, we've identified 2 warning signs for Lion Rock Group (1 is significant) 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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