Is Li Bao Ge Group (HKG:1869) Using Debt Sensibly?

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 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. As with many other companies Li Bao Ge Group Limited (HKG:1869) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Li Bao Ge Group

What Is Li Bao Ge Group's Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2021 Li Bao Ge Group had HK$22.4m of debt, an increase on none, over one year. However, its balance sheet shows it holds HK$31.4m in cash, so it actually has HK$9.02m net cash.

A Look At Li Bao Ge Group's Liabilities

According to the last reported balance sheet, Li Bao Ge Group had liabilities of HK$127.1m due within 12 months, and liabilities of HK$126.0m due beyond 12 months. Offsetting these obligations, it had cash of HK$31.4m as well as receivables valued at HK$25.1m due within 12 months. So it has liabilities totalling HK$196.6m more than its cash and near-term receivables, combined.

This deficit isn't so bad because Li Bao Ge Group is worth HK$410.0m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Despite its noteworthy liabilities, Li Bao Ge Group boasts net cash, so it's fair to say it does not have a heavy debt load! When analysing debt levels, the balance sheet is the obvious place to start. But it is Li Bao Ge 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.

Over 12 months, Li Bao Ge Group reported revenue of HK$279m, which is a gain of 5.1%, although it did not report any earnings before interest and tax. That rate of growth is a bit slow for our taste, but it takes all types to make a world.

So How Risky Is Li Bao Ge Group?

Although Li Bao Ge Group had an earnings before interest and tax (EBIT) loss over the last twelve months, it generated positive free cash flow of HK$17m. So although it is loss-making, it doesn't seem to have too much near-term balance sheet risk, keeping in mind the net cash. Until we see some positive EBIT, we're a bit cautious of the stock, not least because of the rather modest revenue growth. 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. To that end, you should learn about the 2 warning signs we've spotted with Li Bao Ge Group (including 1 which is concerning) .

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.
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