Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, L.K. Technology Holdings Limited (HKG:558) does carry debt. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. When we think about a company's use of debt, we first look at cash and debt together.
What Is L.K. Technology Holdings's Debt?
As you can see below, L.K. Technology Holdings had HK$1.71b of debt, at September 2024, which is about the same as the year before. You can click the chart for greater detail. But on the other hand it also has HK$1.80b in cash, leading to a HK$92.6m net cash position.
A Look At L.K. Technology Holdings' Liabilities
According to the last reported balance sheet, L.K. Technology Holdings had liabilities of HK$4.29b due within 12 months, and liabilities of HK$2.80b due beyond 12 months. Offsetting these obligations, it had cash of HK$1.80b as well as receivables valued at HK$3.57b due within 12 months. So its liabilities total HK$1.72b more than the combination of its cash and short-term receivables.
This deficit isn't so bad because L.K. Technology Holdings is worth HK$4.39b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. While it does have liabilities worth noting, L.K. Technology Holdings also has more cash than debt, so we're pretty confident it can manage its debt safely.
Check out our latest analysis for L.K. Technology Holdings
L.K. Technology Holdings's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine L.K. Technology Holdings'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. L.K. Technology 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, L.K. Technology Holdings 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
Although L.K. Technology Holdings's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of HK$92.6m. So although we see some areas for improvement, we're not too worried about L.K. Technology Holdings's balance sheet. 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. For example, we've discovered 2 warning signs for L.K. Technology Holdings (1 doesn't sit too well with us!) that you should be aware of before investing here.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.