Does Luster Industries Bhd (KLSE:LUSTER) Have A Healthy Balance Sheet?

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Luster Industries Bhd (KLSE:LUSTER) does carry debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Luster Industries Bhd

What Is Luster Industries Bhd's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2022 Luster Industries Bhd had debt of RM32.1m, up from RM21.8m in one year. But on the other hand it also has RM53.1m in cash, leading to a RM20.9m net cash position.

A Look At Luster Industries Bhd's Liabilities

We can see from the most recent balance sheet that Luster Industries Bhd had liabilities of RM168.9m falling due within a year, and liabilities of RM91.7m due beyond that. Offsetting this, it had RM53.1m in cash and RM110.3m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by RM97.3m.

Luster Industries Bhd has a market capitalization of RM268.2m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. While it does have liabilities worth noting, Luster Industries Bhd also has more cash than debt, so we're pretty confident it can manage its debt safely.

The good news is that Luster Industries Bhd has increased its EBIT by 5.4% over twelve months, which should ease any concerns about debt repayment. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Luster Industries Bhd will need earnings to service that debt. 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 company can only pay off debt with cold hard cash, not accounting profits. Luster Industries Bhd 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, Luster Industries Bhd saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing up

Although Luster Industries Bhd's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of RM20.9m. And it also grew its EBIT by 5.4% over the last year. So we don't have any problem with Luster Industries Bhd's use of debt. 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. For example - Luster Industries Bhd has 3 warning signs we think 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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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.