These 4 Measures Indicate That Steve Leung Design Group (HKG:2262) Is Using Debt Reasonably Well

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. We note that Steve Leung Design Group Limited (HKG:2262) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

See our latest analysis for Steve Leung Design Group

What Is Steve Leung Design Group's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Steve Leung Design Group had HK$26.1m of debt in December 2020, down from HK$33.6m, one year before. But it also has HK$275.3m in cash to offset that, meaning it has HK$249.2m net cash.

How Healthy Is Steve Leung Design Group's Balance Sheet?

According to the last reported balance sheet, Steve Leung Design Group had liabilities of HK$172.0m due within 12 months, and liabilities of HK$38.2m due beyond 12 months. Offsetting this, it had HK$275.3m in cash and HK$299.8m in receivables that were due within 12 months. So it actually has HK$364.8m more liquid assets than total liabilities.

This excess liquidity is a great indication that Steve Leung Design Group's balance sheet is almost as strong as Fort Knox. With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Succinctly put, Steve Leung Design Group boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact Steve Leung Design Group's saving grace is its low debt levels, because its EBIT has tanked 27% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Steve Leung Design 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Steve Leung Design 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. Considering the last three years, Steve Leung Design Group actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Summing up

While it is always sensible to investigate a company's debt, in this case Steve Leung Design Group has HK$249.2m in net cash and a decent-looking balance sheet. So we are not troubled with Steve Leung Design Group's debt use. 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. We've identified 1 warning sign with Steve Leung Design Group , and understanding them should be part of your investment process.

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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