Is Lonking Holdings (HKG:3339) A Risky Investment?
Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Lonking Holdings Limited (HKG:3339) does use debt in its business. But is this debt a concern to shareholders?
When Is Debt Dangerous?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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.
See our latest analysis for Lonking Holdings
How Much Debt Does Lonking Holdings Carry?
As you can see below, Lonking Holdings had CN¥1.29b of debt at June 2019, down from CN¥1.52b a year prior. But it also has CN¥4.93b in cash to offset that, meaning it has CN¥3.64b net cash.
How Strong Is Lonking Holdings's Balance Sheet?
We can see from the most recent balance sheet that Lonking Holdings had liabilities of CN¥4.93b falling due within a year, and liabilities of CN¥1.34b due beyond that. Offsetting this, it had CN¥4.93b in cash and CN¥2.98b in receivables that were due within 12 months. So it can boast CN¥1.64b more liquid assets than total liabilities.
This surplus suggests that Lonking Holdings is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that Lonking Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.
But the bad news is that Lonking Holdings has seen its EBIT plunge 17% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Lonking Holdings can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Lonking Holdings 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. Over the last three years, Lonking Holdings recorded free cash flow worth a fulsome 97% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.
Summing up
While it is always sensible to investigate a company's debt, in this case Lonking Holdings has CN¥3.64b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 97% of that EBIT to free cash flow, bringing in CN¥1.1b. So we don't think Lonking Holdings's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 2 warning signs for Lonking Holdings (1 is a bit unpleasant) 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.
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned.
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