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Luk Fook Holdings (International) (HKG:590) Has A Rock Solid Balance Sheet
Warren Buffett famously said, 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Luk Fook Holdings (International) Limited (HKG:590) does carry debt. But should shareholders be worried about its use of debt?
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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
See our latest analysis for Luk Fook Holdings (International)
What Is Luk Fook Holdings (International)'s Net Debt?
The image below, which you can click on for greater detail, shows that at September 2021 Luk Fook Holdings (International) had debt of HK$2.15b, up from HK$634.9m in one year. But on the other hand it also has HK$4.25b in cash, leading to a HK$2.09b net cash position.
How Strong Is Luk Fook Holdings (International)'s Balance Sheet?
According to the last reported balance sheet, Luk Fook Holdings (International) had liabilities of HK$4.21b due within 12 months, and liabilities of HK$303.2m due beyond 12 months. Offsetting these obligations, it had cash of HK$4.25b as well as receivables valued at HK$527.2m due within 12 months. So it actually has HK$256.5m more liquid assets than total liabilities.
This short term liquidity is a sign that Luk Fook Holdings (International) could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Luk Fook Holdings (International) has more cash than debt is arguably a good indication that it can manage its debt safely.
Better yet, Luk Fook Holdings (International) grew its EBIT by 109% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. The balance sheet is clearly the area to focus on when you are analysing debt. 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Luk Fook Holdings (International) 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. Over the last three years, Luk Fook Holdings (International) actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
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$2.09b, as well as more liquid assets than liabilities. The cherry on top was that in converted 140% of that EBIT to free cash flow, bringing in HK$1.4b. So is Luk Fook Holdings (International)'s debt a risk? It doesn't seem so to us. 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. Case in point: We've spotted 1 warning sign for Luk Fook Holdings (International) you should be aware of.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.
About SEHK:590
Luk Fook Holdings (International)
An investment holding company, engages in sourcing, designing, wholesaling, trademark licensing, and retailing various gold and platinum jewelry, and gem-set jewelry products.
Very undervalued with flawless balance sheet and pays a dividend.
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