Are Lonking Holdings (HKG: 3339) using too much debt?
Berkshire Hathaway’s Charlie Munger-backed external fund manager Li Lu doesn’t care when he says, “The biggest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital ”. It is natural to consider a company’s balance sheet when considering how risky it is, as debt is often involved when a business collapses. We notice that Lonking Holdings Limited (HKG: 3339) has debt on its balance sheet. But the most important question is: what is the risk that this debt creates?
What risk does debt entail?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. However, a more common (but still painful) scenario is that he has to raise new equity at low cost, thereby constantly diluting shareholders. Of course, debt can be an important tool in businesses, especially large cap companies. The first thing to do when considering how much debt a business uses is to look at its cash flow and debt together.
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How much debt is Lonking Holdings?
You can click on the graph below to see the historical figures, but it shows that Lonking Holdings had CNY 663.5 million in debt as of December 2020, up from CN’s 709.3 million a year earlier. But on the other hand, it also has 4.53 billion yen in cash, which leads to a net cash position of 3.87 billion yen.
How strong is Lonking Holdings’ balance sheet?
The latest balance sheet data shows that Lonking Holdings had commitments of 7.10 billion yen due in one year and commitments of 84.7 million yen due thereafter. In return, he had 4.53 billion yen in cash and 3.36 billion yen in receivables due within 12 months. Thus, it can boast of CNY 714.7 million more in liquid assets than total Liabilities.
This short-term liquidity is a sign that Lonking Holdings could likely repay its debt with ease, as its balance sheet is far from tight. In short, Lonking Holdings has clear cash flow, so it’s fair to say it doesn’t have heavy debt!
Fortunately, Lonking Holdings increased its EBIT by 9.0% last year, which makes this leverage even more manageable. The balance sheet is clearly the area to focus on when analyzing debt. But it is future earnings, more than anything, that will determine Lonking Holdings’ ability to maintain a healthy balance sheet going forward. So, if you want to see what the professionals are thinking, you might find this free analyst earnings forecast report interesting.
Finally, a business needs free cash flow to pay off debt; accounting profits do not reduce it. Lonking Holdings may have net cash on the balance sheet, but it’s always interesting to see how well the company converts its earnings before interest and taxes (EBIT) into free cash flow, as this will influence both its needs and its capacity. . to manage debt. Over the past three years, Lonking Holdings’ free cash flow has stood at 44% of its EBIT, less than we expected. This low cash conversion makes debt management more difficult.
While we sympathize with investors who find debt of concern, you should keep in mind that Lonking Holdings has net cash of 3.87 billion yen, as well as more liquid assets than liabilities. And it has also increased its EBIT by 9.0% over the past year. So is Lonking Holdings’ debt a risk? It does not seem to us. The balance sheet is clearly the area to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist off the balance sheet. Concrete example: we have spotted 3 warning signs for Lonking Holdings you need to be aware of that, and one of them is a bit nasty.
If you want to invest in companies that can generate profits without the burden of debt, take a look at this free list of growing companies that have net cash on the balance sheet.
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