Luster Industries Bhd (KLSE:LUSTER) Takes On Some Risk With Its Use Of Debt

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Luster Industries Bhd (KLSE:LUSTER) does have debt on its balance sheet. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Luster Industries Bhd

What Is Luster Industries Bhd's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2022 Luster Industries Bhd had RM38.9m of debt, an increase on RM16.1m, over one year. But it also has RM70.7m in cash to offset that, meaning it has RM31.7m net cash.

How Strong Is Luster Industries Bhd's Balance Sheet?

According to the last reported balance sheet, Luster Industries Bhd had liabilities of RM193.7m due within 12 months, and liabilities of RM90.9m due beyond 12 months. On the other hand, it had cash of RM70.7m and RM87.8m worth of receivables due within a year. So it has liabilities totalling RM126.2m more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Luster Industries Bhd has a market capitalization of RM317.4m, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. Despite its noteworthy liabilities, Luster Industries Bhd boasts net cash, so it's fair to say it does not have a heavy debt load!

On the other hand, Luster Industries Bhd saw its EBIT drop by 6.9% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. There's no doubt that we learn most about debt from the balance sheet. But it is Luster Industries Bhd'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. 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. During the last three years, Luster Industries Bhd burned a lot of cash. 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 RM31.7m. So although we see some areas for improvement, we're not too worried about Luster Industries Bhd's balance sheet. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 3 warning signs for Luster Industries Bhd that you should be aware of before investing here.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.