We Think Luster Industries Bhd (KLSE:LUSTER) Is Taking Some Risk With Its Debt

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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 can see that Luster Industries Bhd (KLSE:LUSTER) does use debt in its business. But the real question is whether this debt is making the company risky.

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. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt 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 2024 Luster Industries Bhd had RM70.3m of debt, an increase on RM65.1m, over one year. But on the other hand it also has RM93.3m in cash, leading to a RM23.1m 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 RM152.1m falling due within a year, and liabilities of RM122.2m due beyond that. Offsetting this, it had RM93.3m in cash and RM66.0m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by RM115.0m.

This deficit is considerable relative to its market capitalization of RM164.6m, so it does suggest shareholders should keep an eye on Luster Industries Bhd's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. 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.

Although Luster Industries Bhd made a loss at the EBIT level, last year, it was also good to see that it generated RM6.2m in EBIT over the last twelve months. 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 when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

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. During the last year, Luster Industries Bhd burned a lot of cash. 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 RM23.1m. 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. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 2 warning signs we've spotted with Luster Industries Bhd (including 1 which doesn't sit too well with us) .

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. 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.