David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. We can see that Lion Rock Group Limited (HKG:1127) does use debt in its business. But is this debt a concern to shareholders?
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. 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, 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does Lion Rock Group Carry?
The image below, which you can click on for greater detail, shows that at December 2018 Lion Rock Group had debt of HK$288.6m, up from HK$70.9m in one year. However, it does have HK$509.0m in cash offsetting this, leading to net cash of HK$220.4m.
How Healthy Is Lion Rock Group's Balance Sheet?
The latest balance sheet data shows that Lion Rock Group had liabilities of HK$551.3m due within a year, and liabilities of HK$26.1m falling due after that. Offsetting these obligations, it had cash of HK$509.0m as well as receivables valued at HK$491.3m due within 12 months. So it can boast HK$422.9m more liquid assets than total liabilities.
This luscious liquidity implies that Lion Rock Group's balance sheet is sturdy like a giant sequoia tree. With this in mind one could posit that its balance sheet is as strong as beautiful a rare rhino. Succinctly put, Lion Rock Group boasts net cash, so it's fair to say it does not have a heavy debt load!
In fact Lion Rock Group's saving grace is its low debt levels, because its EBIT has tanked 20% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Lion Rock Group'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.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. Lion Rock Group 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. During the last three years, Lion Rock Group generated free cash flow amounting to a very robust 86% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.
While we empathize with investors who find debt concerning, you should keep in mind that Lion Rock Group has net cash of HK$220m, as well as more liquid assets than liabilities. The cherry on top was that in converted 86% of that EBIT to free cash flow, bringing in -HK$62.4m. So is Lion Rock Group's debt a risk? It doesn't seem so to us. Another factor that would give us confidence in Lion Rock Group would be if insiders have been buying shares: if you're conscious of that signal too, you can find out instantly by clicking this link.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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