Is Hong Lai Huat Group (SGX:CTO) Using Debt In A Risky Way?

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, Hong Lai Huat Group Limited (SGX:CTO) does carry debt. 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. 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, 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 think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Hong Lai Huat Group

What Is Hong Lai Huat Group's Net Debt?

The image below, which you can click on for greater detail, shows that Hong Lai Huat Group had debt of S$8.14m at the end of June 2024, a reduction from S$11.4m over a year. On the flip side, it has S$5.84m in cash leading to net debt of about S$2.30m.

A Look At Hong Lai Huat Group's Liabilities

We can see from the most recent balance sheet that Hong Lai Huat Group had liabilities of S$21.5m falling due within a year, and liabilities of S$5.94m due beyond that. On the other hand, it had cash of S$5.84m and S$647.0k worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by S$20.9m.

When you consider that this deficiency exceeds the company's S$19.7m market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Hong Lai Huat Group 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.

Given it has no significant operating revenue at the moment, shareholders will be hoping Hong Lai Huat Group can make progress and gain better traction for the business, before it runs low on cash.

Caveat Emptor

While Hong Lai Huat Group's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost a very considerable S$9.2m at the EBIT level. When we look at that alongside the significant liabilities, we're not particularly confident about the company. It would need to improve its operations quickly for us to be interested in it. Not least because it burned through S$6.8m in negative free cash flow over the last year. That means it's on the risky side of things. 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. Case in point: We've spotted 5 warning signs for Hong Lai Huat Group you should be aware of, and 4 of them can't be ignored.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.