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 Luk Fook Holdings (International) Limited (HKG:590) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Luk Fook Holdings (International)

What Is Luk Fook Holdings (International)'s Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Luk Fook Holdings (International) had HK$1.41b of debt, an increase on HK$1.15b, over one year. But it also has HK$1.93b in cash to offset that, meaning it has HK$526.1m net cash.

A Look At Luk Fook Holdings (International)'s Liabilities

According to the last reported balance sheet, Luk Fook Holdings (International) had liabilities of HK$3.49b due within 12 months, and liabilities of HK$434.1m due beyond 12 months. Offsetting this, it had HK$1.93b in cash and HK$477.3m in receivables that were due within 12 months. So it has liabilities totalling HK$1.51b more than its cash and near-term receivables, combined.

Since publicly traded Luk Fook Holdings (International) shares are worth a total of HK$8.47b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Luk Fook Holdings (International) boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Luk Fook Holdings (International) if management cannot prevent a repeat of the 35% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Luk Fook Holdings (International)'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, a company can only pay off debt with cold hard cash, not accounting profits. Luk Fook Holdings (International) 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 most recent three years, Luk Fook Holdings (International) recorded free cash flow worth 68% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

Although Luk Fook Holdings (International)'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$526.1m. And it impressed us with free cash flow of HK$1.9b, being 68% of its EBIT. So we are not troubled with Luk Fook Holdings (International)'s debt use. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Luk Fook Holdings (International) has 1 warning sign we think 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.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.