Is Luk Hing Entertainment Group Holdings (HKG:8052) Using Debt In A Risky Way?

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 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 Luk Hing Entertainment Group Holdings Limited (HKG:8052) does have debt on its balance sheet. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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.

View our latest analysis for Luk Hing Entertainment Group Holdings

How Much Debt Does Luk Hing Entertainment Group Holdings Carry?

As you can see below, Luk Hing Entertainment Group Holdings had HK$64.0m of debt, at June 2021, which is about the same as the year before. You can click the chart for greater detail. However, it does have HK$20.9m in cash offsetting this, leading to net debt of about HK$43.1m.

A Look At Luk Hing Entertainment Group Holdings' Liabilities

According to the last reported balance sheet, Luk Hing Entertainment Group Holdings had liabilities of HK$79.2m due within 12 months, and liabilities of HK$126.8m due beyond 12 months. Offsetting this, it had HK$20.9m in cash and HK$25.2m in receivables that were due within 12 months. So its liabilities total HK$160.0m more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the HK$101.5m 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'd watch its balance sheet closely, without a doubt. At the end of the day, Luk Hing Entertainment Group 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 Luk Hing Entertainment Group Holdings's earnings that will influence how the balance sheet holds up in the future. 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.

In the last year Luk Hing Entertainment Group Holdings wasn't profitable at an EBIT level, but managed to grow its revenue by 9.0%, to HK$199m. We usually like to see faster growth from unprofitable companies, but each to their own.

Caveat Emptor

Over the last twelve months Luk Hing Entertainment Group Holdings produced an earnings before interest and tax (EBIT) loss. Indeed, it lost a very considerable HK$28m at the EBIT level. When we look at that alongside the significant liabilities, we're not particularly confident about the company. It would need to improve its operations quickly for us to be interested in it. For example, we would not want to see a repeat of last year's loss of HK$25m. In the meantime, we consider the stock to be risky. 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. We've identified 4 warning signs with Luk Hing Entertainment Group Holdings (at least 1 which makes us a bit uncomfortable) , and understanding them should be part of your investment process.

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.

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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