Luxchem Corporation Berhad (KLSE:LUXCHEM) Seems To Use Debt Rather Sparingly

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 Luxchem Corporation Berhad (KLSE:LUXCHEM) does use debt in its business. But is this debt a concern to shareholders?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Luxchem Corporation Berhad

What Is Luxchem Corporation Berhad's Debt?

As you can see below, Luxchem Corporation Berhad had RM63.8m of debt, at December 2020, which is about the same as the year before. You can click the chart for greater detail. However, its balance sheet shows it holds RM140.4m in cash, so it actually has RM76.6m net cash.

How Strong Is Luxchem Corporation Berhad's Balance Sheet?

According to the last reported balance sheet, Luxchem Corporation Berhad had liabilities of RM147.7m due within 12 months, and liabilities of RM2.37m due beyond 12 months. Offsetting these obligations, it had cash of RM140.4m as well as receivables valued at RM162.4m due within 12 months. So it actually has RM152.6m more liquid assets than total liabilities.

This excess liquidity suggests that Luxchem Corporation Berhad is taking a careful approach to debt. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Succinctly put, Luxchem Corporation Berhad boasts net cash, so it's fair to say it does not have a heavy debt load!

And we also note warmly that Luxchem Corporation Berhad grew its EBIT by 16% last year, making its debt load easier to handle. 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 Luxchem Corporation Berhad'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 company can only pay off debt with cold hard cash, not accounting profits. While Luxchem Corporation Berhad 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. During the last three years, Luxchem Corporation Berhad produced sturdy free cash flow equating to 55% 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 it is always sensible to investigate a company's debt, in this case Luxchem Corporation Berhad has RM76.6m in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 16% over the last year. So we don't think Luxchem Corporation Berhad's use of debt is 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. For instance, we've identified 3 warning signs for Luxchem Corporation Berhad (1 doesn't sit too well with us) you should be aware of.

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. 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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