Health Check: How Prudently Does Luen Thai Holdings (HKG:311) Use Debt?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. As with many other companies Luen Thai Holdings Limited (HKG:311) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth 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 Thai Holdings

What Is Luen Thai Holdings's Debt?

The chart below, which you can click on for greater detail, shows that Luen Thai Holdings had US$160.6m in debt in December 2020; about the same as the year before. However, it does have US$109.8m in cash offsetting this, leading to net debt of about US$50.7m.

How Strong Is Luen Thai Holdings' Balance Sheet?

We can see from the most recent balance sheet that Luen Thai Holdings had liabilities of US$285.2m falling due within a year, and liabilities of US$64.8m due beyond that. Offsetting these obligations, it had cash of US$109.8m as well as receivables valued at US$128.3m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$111.8m.

This deficit casts a shadow over the US$50.6m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Luen Thai Holdings would probably need a major re-capitalization if its creditors were to demand repayment. There's no doubt that we learn most about debt from the balance sheet. But it is Luen Thai 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.

In the last year Luen Thai Holdings had a loss before interest and tax, and actually shrunk its revenue by 28%, to US$697m. That makes us nervous, to say the least.

Caveat Emptor

While Luen Thai 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 US$23m at the EBIT level. Considering that alongside the liabilities mentioned above make us nervous about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. Not least because it had negative free cash flow of US$8.5m over the last twelve months. So suffice it to say we consider the stock to be risky. 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 3 warning signs for Luen Thai Holdings you should be aware of, and 2 of them are 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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