These 4 Measures Indicate That Luks Group (Vietnam Holdings) (HKG:366) Is Using Debt Reasonably Well

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Luks Group (Vietnam Holdings) Company Limited (HKG:366) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out the opportunities and risks within the HK Basic Materials industry.

What Is Luks Group (Vietnam Holdings)'s Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2022 Luks Group (Vietnam Holdings) had HK$84.8m of debt, an increase on HK$35.0m, over one year. But it also has HK$456.1m in cash to offset that, meaning it has HK$371.3m net cash.

How Strong Is Luks Group (Vietnam Holdings)'s Balance Sheet?

The latest balance sheet data shows that Luks Group (Vietnam Holdings) had liabilities of HK$231.2m due within a year, and liabilities of HK$243.6m falling due after that. On the other hand, it had cash of HK$456.1m and HK$50.7m worth of receivables due within a year. So it can boast HK$32.0m more liquid assets than total liabilities.

This short term liquidity is a sign that Luks Group (Vietnam Holdings) could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Luks Group (Vietnam Holdings) has more cash than debt is arguably a good indication that it can manage its debt safely.

In fact Luks Group (Vietnam Holdings)'s saving grace is its low debt levels, because its EBIT has tanked 26% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Luks Group (Vietnam 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. Luks Group (Vietnam 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. During the last three years, Luks Group (Vietnam Holdings) produced sturdy free cash flow equating to 57% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Luks Group (Vietnam Holdings) has net cash of HK$371.3m, as well as more liquid assets than liabilities. So we don't have any problem with Luks Group (Vietnam Holdings)'s use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 4 warning signs for Luks Group (Vietnam Holdings) you should be aware of, and 1 of them can't be ignored.

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. 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.