We Think Luster Industries Bhd (KLSE:LUSTER) Is Taking Some Risk With Its 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.' 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. We note that Luster Industries Bhd (KLSE:LUSTER) does have debt on its balance sheet. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See 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 June 2022 Luster Industries Bhd had RM43.1m of debt, an increase on RM19.6m, over one year. However, its balance sheet shows it holds RM64.1m in cash, so it actually has RM21.1m net cash.

How Strong Is Luster Industries Bhd's Balance Sheet?

The latest balance sheet data shows that Luster Industries Bhd had liabilities of RM196.6m due within a year, and liabilities of RM90.5m falling due after that. On the other hand, it had cash of RM64.1m and RM109.5m worth of receivables due within a year. So it has liabilities totalling RM113.4m more than its cash and near-term receivables, combined.

This deficit isn't so bad because Luster Industries Bhd is worth RM272.0m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Despite its noteworthy liabilities, Luster Industries Bhd boasts net cash, so it's fair to say it does not have a heavy debt load!

Luster Industries Bhd's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of debt. The balance sheet is clearly the area to focus on when you are analysing debt. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Luster 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. Over the last three years, Luster Industries Bhd saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While Luster Industries Bhd does have more liabilities than liquid assets, it also has net cash of RM21.1m. So although we see some areas for improvement, we're not too worried about Luster Industries Bhd's balance sheet. 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. For example Luster Industries Bhd has 4 warning signs (and 2 which are concerning) we think you should know about.

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.