Is Lii Hen Industries Bhd (KLSE:LIIHEN) Using Too Much Debt?

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, Lii Hen Industries Bhd (KLSE:LIIHEN) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. 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 think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Lii Hen Industries Bhd

What Is Lii Hen Industries Bhd's Debt?

As you can see below, Lii Hen Industries Bhd had RM7.58m of debt at September 2020, down from RM15.2m a year prior. However, its balance sheet shows it holds RM169.7m in cash, so it actually has RM162.1m net cash.

How Strong Is Lii Hen Industries Bhd's Balance Sheet?

According to the last reported balance sheet, Lii Hen Industries Bhd had liabilities of RM144.9m due within 12 months, and liabilities of RM27.4m due beyond 12 months. On the other hand, it had cash of RM169.7m and RM87.8m worth of receivables due within a year. So it can boast RM85.2m more liquid assets than total liabilities.

This short term liquidity is a sign that Lii Hen Industries Bhd could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Lii Hen Industries Bhd boasts net cash, so it's fair to say it does not have a heavy debt load!

Fortunately, Lii Hen Industries Bhd grew its EBIT by 5.7% in the last year, making that debt load look even more manageable. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Lii Hen Industries Bhd can strengthen its balance sheet over time. 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 Lii Hen Industries Bhd 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, Lii Hen Industries Bhd produced sturdy free cash flow equating to 73% 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 Lii Hen Industries Bhd has net cash of RM162.1m, as well as more liquid assets than liabilities. The cherry on top was that in converted 73% of that EBIT to free cash flow, bringing in RM71m. So we don't think Lii Hen Industries Bhd's use of debt is risky. 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. Consider risks, for instance. Every company has them, and we've spotted 2 warning signs for Lii Hen Industries Bhd you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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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