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.' 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. As with many other companies Leofoo Development Co., Ltd. (TPE:2705) makes use of debt. But is this debt a concern to shareholders?
When Is Debt A Problem?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.
View our latest analysis for Leofoo Development
What Is Leofoo Development's Net Debt?
As you can see below, Leofoo Development had NT$4.03b of debt, at September 2020, which is about the same as the year before. You can click the chart for greater detail. However, it also had NT$360.9m in cash, and so its net debt is NT$3.67b.
How Strong Is Leofoo Development's Balance Sheet?
The latest balance sheet data shows that Leofoo Development had liabilities of NT$1.65b due within a year, and liabilities of NT$8.75b falling due after that. Offsetting this, it had NT$360.9m in cash and NT$109.8m in receivables that were due within 12 months. So it has liabilities totalling NT$9.93b more than its cash and near-term receivables, combined.
The deficiency here weighs heavily on the NT$3.84b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. After all, Leofoo Development would likely require a major re-capitalisation if it had to pay its creditors today. When analysing debt levels, the balance sheet is the obvious place to start. But it is Leofoo Development's earnings that will influence how the balance sheet holds up in the future. 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.
In the last year Leofoo Development had a loss before interest and tax, and actually shrunk its revenue by 8.5%, to NT$1.8b. That's not what we would hope to see.
Caveat Emptor
Importantly, Leofoo Development had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost NT$246m at the EBIT level. Combining this information with the significant liabilities we already touched on makes us very hesitant about this stock, to say the least. That said, it is possible that the company will turn its fortunes around. But we think that is unlikely since it is low on liquid assets, and made a loss of NT$353m in the last year. So while it's not wise to assume the company will fail, we do think it's risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example - Leofoo Development has 1 warning sign we think you should be aware of.
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. 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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About TWSE:2705
Acceptable track record with worrying balance sheet.
