We Think Lion Rock Group (HKG:1127) Can Stay On Top Of Its 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. Importantly, Lion Rock Group Limited (HKG:1127) does carry debt. But should shareholders be worried about its use of debt?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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 examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Lion Rock Group

How Much Debt Does Lion Rock Group Carry?

As you can see below, Lion Rock Group had HK$231.3m of debt at June 2020, down from HK$271.3m a year prior. However, its balance sheet shows it holds HK$364.7m in cash, so it actually has HK$133.4m net cash.

How Healthy Is Lion Rock Group's Balance Sheet?

We can see from the most recent balance sheet that Lion Rock Group had liabilities of HK$495.1m falling due within a year, and liabilities of HK$81.5m due beyond that. Offsetting these obligations, it had cash of HK$364.7m as well as receivables valued at HK$502.7m due within 12 months. So it actually has HK$290.8m more liquid assets than total liabilities.

This surplus liquidity suggests that Lion Rock Group's 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 just as strong as misogynists are weak. Succinctly put, Lion Rock Group boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Lion Rock Group if management cannot prevent a repeat of the 41% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. 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 Lion Rock Group will need earnings to service that debt. 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. 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. Looking at the most recent three years, Lion Rock Group recorded free cash flow of 39% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While it is always sensible to investigate a company's debt, in this case Lion Rock Group has HK$133.4m in net cash and a decent-looking balance sheet. So we are not troubled with Lion Rock Group's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for Lion Rock Group you should be aware of, and 1 of them makes us a bit uncomfortable.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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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