LKL International Berhad (KLSE:LKL) Could Easily Take On More Debt

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. We can see that LKL International Berhad (KLSE:LKL) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. 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 LKL International Berhad

What Is LKL International Berhad's Net Debt?

The image below, which you can click on for greater detail, shows that at July 2020 LKL International Berhad had debt of RM6.50m, up from RM6.19m in one year. However, its balance sheet shows it holds RM15.8m in cash, so it actually has RM9.26m net cash.

How Healthy Is LKL International Berhad's Balance Sheet?

We can see from the most recent balance sheet that LKL International Berhad had liabilities of RM9.00m falling due within a year, and liabilities of RM5.05m due beyond that. On the other hand, it had cash of RM15.8m and RM14.1m worth of receivables due within a year. So it can boast RM15.8m more liquid assets than total liabilities.

This surplus suggests that LKL International Berhad has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that LKL International Berhad has more cash than debt is arguably a good indication that it can manage its debt safely.

Although LKL International Berhad made a loss at the EBIT level, last year, it was also good to see that it generated RM6.6m in EBIT over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is LKL International Berhad'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While LKL International 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 year, LKL International Berhad produced sturdy free cash flow equating to 65% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While it is always sensible to investigate a company's debt, in this case LKL International Berhad has RM9.26m in net cash and a decent-looking balance sheet. So is LKL International Berhad's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Consider for instance, the ever-present spectre of investment risk. We've identified 3 warning signs with LKL International Berhad (at least 1 which is potentially serious) , and understanding them should be part of your investment process.

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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