Does Luhai Holding (TPE:2115) Have A Healthy Balance Sheet?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. We note that Luhai Holding Corp. (TPE:2115) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Luhai Holding

What Is Luhai Holding's Debt?

The chart below, which you can click on for greater detail, shows that Luhai Holding had NT$779.3m in debt in September 2020; about the same as the year before. But it also has NT$1.11b in cash to offset that, meaning it has NT$327.6m net cash.

How Strong Is Luhai Holding's Balance Sheet?

According to the last reported balance sheet, Luhai Holding had liabilities of NT$709.8m due within 12 months, and liabilities of NT$924.0m due beyond 12 months. Offsetting this, it had NT$1.11b in cash and NT$696.8m in receivables that were due within 12 months. So it actually has NT$169.9m more liquid assets than total liabilities.

This short term liquidity is a sign that Luhai Holding could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Luhai Holding has more cash than debt is arguably a good indication that it can manage its debt safely.

But the other side of the story is that Luhai Holding saw its EBIT decline by 9.8% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Luhai Holding's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Luhai Holding 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, Luhai Holding 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 it is always sensible to investigate a company's debt, in this case Luhai Holding has NT$327.6m in net cash and a decent-looking balance sheet. So we don't have any problem with Luhai Holding's use of debt. 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. Take risks, for example - Luhai Holding has 2 warning signs (and 1 which is a bit unpleasant) we think you should know about.

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. 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.
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