Luen Thai Holdings (HKG:311) Has A Somewhat Strained Balance Sheet

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 is this debt a concern to shareholders?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Luen Thai Holdings

What Is Luen Thai Holdings's Debt?

As you can see below, at the end of June 2022, Luen Thai Holdings had US$177.6m of debt, up from US$154.4m a year ago. Click the image for more detail. But on the other hand it also has US$179.9m in cash, leading to a US$2.23m net cash position.

How Healthy Is Luen Thai Holdings' Balance Sheet?

We can see from the most recent balance sheet that Luen Thai Holdings had liabilities of US$387.5m falling due within a year, and liabilities of US$43.6m due beyond that. On the other hand, it had cash of US$179.9m and US$134.5m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$116.7m.

The deficiency here weighs heavily on the US$49.4m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. At the end of the day, Luen Thai Holdings would probably need a major re-capitalization if its creditors were to demand repayment. Given that Luen Thai Holdings has more cash than debt, we're pretty confident it can handle its debt, despite the fact that it has a lot of liabilities in total.

Notably, Luen Thai Holdings made a loss at the EBIT level, last year, but improved that to positive EBIT of US$29m in the last twelve months. 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 Luen Thai 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Luen Thai Holdings may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. In the last year, Luen Thai Holdings's free cash flow amounted to 34% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

Although Luen Thai Holdings's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$2.23m. Despite the cash, we do find Luen Thai Holdings's level of total liabilities concerning, so we're not particularly comfortable with the stock. 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 example Luen Thai Holdings has 3 warning signs (and 1 which doesn't sit too well with us) we think you should know about.

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.

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.