Warren Buffett famously said, ‘Volatility is far from synonymous with risk.’ 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 note that Lii Hen Industries Bhd (KLSE:LIIHEN) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
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. Part and parcel of capitalism is the process of ‘creative destruction’ where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well – and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
View our latest analysis for Lii Hen Industries Bhd
What Is Lii Hen Industries Bhd’s Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of December 2020 Lii Hen Industries Bhd had RM28.8m of debt, an increase on RM17.0m, over one year. But on the other hand it also has RM159.7m in cash, leading to a RM130.9m net cash position.
How Strong Is Lii Hen Industries Bhd’s Balance Sheet?
The latest balance sheet data shows that Lii Hen Industries Bhd had liabilities of RM150.1m due within a year, and liabilities of RM26.9m falling due after that. Offsetting these obligations, it had cash of RM159.7m as well as receivables valued at RM78.2m due within 12 months. So it actually has RM61.0m more liquid assets than total liabilities.
This surplus suggests that Lii Hen Industries Bhd has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Lii Hen Industries Bhd has more cash than debt is arguably a good indication that it can manage its debt safely.
On the other hand, Lii Hen Industries Bhd saw its EBIT drop by 3.3% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Lii Hen Industries Bhd 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.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Lii Hen Industries Bhd has net cash on its balance sheet, it’s still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the most recent three years, Lii Hen Industries Bhd recorded free cash flow worth 64% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
While we empathize with investors who find debt concerning, you should keep in mind that Lii Hen Industries Bhd has net cash of RM130.9m, as well as more liquid assets than liabilities. So we don’t think Lii Hen Industries Bhd’s use of debt is risky. There’s no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we’ve discovered 2 warning signs for Lii Hen Industries Bhd (1 doesn’t sit too well with us!) that you should be aware of before investing here.
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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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. 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.
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