Is Hong Lai Huat Group (SGX:CTO) Using Too Much 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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Hong Lai Huat Group Limited (SGX:CTO) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Hong Lai Huat Group

How Much Debt Does Hong Lai Huat Group Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2023 Hong Lai Huat Group had S$11.4m of debt, an increase on S$4.10m, over one year. However, because it has a cash reserve of S$6.02m, its net debt is less, at about S$5.42m.

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$10.6m falling due within a year, and liabilities of S$14.7m due beyond that. Offsetting these obligations, it had cash of S$6.02m as well as receivables valued at S$1.53m due within 12 months. So its liabilities total S$17.7m more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of S$25.9m. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Hong Lai Huat Group's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year Hong Lai Huat Group had a loss before interest and tax, and actually shrunk its revenue by 76%, to S$1.2m. To be frank that doesn't bode well.

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. Its EBIT loss was a whopping S$11m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. However, it doesn't help that it burned through S$1.6m of cash over the last year. So in short it's a really risky stock. 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. Be aware that Hong Lai Huat Group is showing 3 warning signs in our investment analysis , and 2 of those are significant...

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.