Is Stelux Holdings International (HKG:84) Using Too Much Debt?

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 can see that Stelux Holdings International Limited (HKG:84) does use debt in its business. But is this debt a concern to shareholders?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 step when considering a company's debt levels is to consider its cash and debt together.

Our analysis indicates that 84 is potentially undervalued!

How Much Debt Does Stelux Holdings International Carry?

You can click the graphic below for the historical numbers, but it shows that Stelux Holdings International had HK$360.2m of debt in September 2022, down from HK$492.3m, one year before. However, because it has a cash reserve of HK$156.9m, its net debt is less, at about HK$203.3m.

A Look At Stelux Holdings International's Liabilities

We can see from the most recent balance sheet that Stelux Holdings International had liabilities of HK$624.4m falling due within a year, and liabilities of HK$57.7m due beyond that. Offsetting these obligations, it had cash of HK$156.9m as well as receivables valued at HK$91.0m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$434.2m.

The deficiency here weighs heavily on the HK$60.7m 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 definitely think shareholders need to watch this one closely. After all, Stelux Holdings International would likely require a major re-capitalisation if it had to pay its creditors today. When analysing debt levels, the balance sheet is the obvious place to start. But it is Stelux Holdings International'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 Stelux Holdings International wasn't profitable at an EBIT level, but managed to grow its revenue by 14%, to HK$795m. That rate of growth is a bit slow for our taste, but it takes all types to make a world.

Caveat Emptor

Over the last twelve months Stelux Holdings International produced an earnings before interest and tax (EBIT) loss. Indeed, it lost a very considerable HK$68m at the EBIT level. When you combine this with the very significant balance sheet liabilities mentioned above, we are so wary of it that we are basically at a loss for the right words. Like every long-shot we're sure it has a glossy presentation outlining its blue-sky potential. But the reality is that it is low on liquid assets relative to liabilities, and it lost HK$4.2m in the last year. So we're not very excited about owning this stock. Its too risky for us. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 2 warning signs for Stelux Holdings International that you should be aware of.

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.