Does Luo Lih-Fen Holding (TPE:6666) Have A Healthy Balance Sheet?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 note that Luo Lih-Fen Holding Co., Ltd. (TPE:6666) does have debt on its balance sheet. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. 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. 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.

Check out our latest analysis for Luo Lih-Fen Holding

How Much Debt Does Luo Lih-Fen Holding Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Luo Lih-Fen Holding had NT$92.2m of debt, an increase on none, over one year. But it also has NT$1.07b in cash to offset that, meaning it has NT$973.2m net cash.

How Healthy Is Luo Lih-Fen Holding's Balance Sheet?

We can see from the most recent balance sheet that Luo Lih-Fen Holding had liabilities of NT$253.0m falling due within a year, and liabilities of NT$104.4m due beyond that. On the other hand, it had cash of NT$1.07b and NT$15.7m worth of receivables due within a year. So it actually has NT$723.7m more liquid assets than total liabilities.

It's good to see that Luo Lih-Fen Holding has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that Luo Lih-Fen Holding has more cash than debt is arguably a good indication that it can manage its debt safely.

It is just as well that Luo Lih-Fen Holding's load is not too heavy, because its EBIT was down 80% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Luo Lih-Fen 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Luo Lih-Fen Holding may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Looking at the most recent three years, Luo Lih-Fen Holding recorded free cash flow of 38% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Luo Lih-Fen Holding has net cash of NT$973.2m, as well as more liquid assets than liabilities. So we are not troubled with Luo Lih-Fen Holding's debt use. 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. Consider for instance, the ever-present spectre of investment risk. We've identified 3 warning signs with Luo Lih-Fen Holding (at least 1 which makes us a bit uncomfortable) , and understanding them should be part of your investment process.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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