Does Luk Fook Holdings (International) (HKG:590) Have A Healthy 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 Luk Fook Holdings (International) Limited (HKG:590) makes use of debt. But should shareholders be worried about its use of debt?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Luk Fook Holdings (International)

What Is Luk Fook Holdings (International)'s Debt?

You can click the graphic below for the historical numbers, but it shows that Luk Fook Holdings (International) had HK$540.1m of debt in March 2023, down from HK$1.95b, one year before. However, it does have HK$2.35b in cash offsetting this, leading to net cash of HK$1.81b.

A Look At Luk Fook Holdings (International)'s Liabilities

Zooming in on the latest balance sheet data, we can see that Luk Fook Holdings (International) had liabilities of HK$2.47b due within 12 months and liabilities of HK$241.1m due beyond that. Offsetting this, it had HK$2.35b in cash and HK$493.1m in receivables that were due within 12 months. So it actually has HK$133.1m more liquid assets than total liabilities.

Having regard to Luk Fook Holdings (International)'s size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the HK$12.1b company is struggling for cash, we still think it's worth monitoring its balance sheet. Succinctly put, Luk Fook Holdings (International) boasts net cash, so it's fair to say it does not have a heavy debt load!

But the other side of the story is that Luk Fook Holdings (International) saw its EBIT decline by 4.0% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Luk Fook Holdings (International)'s ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Luk Fook Holdings (International) 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. Over the last three years, Luk Fook Holdings (International) recorded free cash flow worth a fulsome 89% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Luk Fook Holdings (International) has net cash of HK$1.81b, as well as more liquid assets than liabilities. The cherry on top was that in converted 89% of that EBIT to free cash flow, bringing in HK$1.2b. So we don't think Luk Fook Holdings (International)'s use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 1 warning sign for Luk Fook Holdings (International) that you should be aware of before investing here.

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.