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 can see that Luster Industries Bhd (KLSE:LUSTER) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Luster Industries Bhd

How Much Debt Does Luster Industries Bhd Carry?

As you can see below, at the end of September 2024, Luster Industries Bhd had RM76.9m of debt, up from RM62.9m a year ago. Click the image for more detail. But it also has RM92.2m in cash to offset that, meaning it has RM15.3m net cash.

How Strong Is Luster Industries Bhd's Balance Sheet?

According to the last reported balance sheet, Luster Industries Bhd had liabilities of RM155.2m due within 12 months, and liabilities of RM120.6m due beyond 12 months. Offsetting these obligations, it had cash of RM92.2m as well as receivables valued at RM63.1m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by RM120.5m.

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. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. Despite its noteworthy liabilities, Luster Industries Bhd boasts net cash, so it's fair to say it does not have a heavy debt load!

Although Luster Industries Bhd made a loss at the EBIT level, last year, it was also good to see that it generated RM3.9m in EBIT over the last twelve months. There's no doubt that we learn most about debt from the balance sheet. 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 year, 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

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 RM15.3m. So although we see some areas for improvement, we're not too worried about Luster Industries Bhd's balance sheet. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Luster Industries Bhd (of which 1 is significant!) you should know about.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.