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 the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

How Much Debt Does Luk Fook Holdings (International) Carry?

The image below, which you can click on for greater detail, shows that at March 2024 Luk Fook Holdings (International) had debt of HK$1.43b, up from HK$540.1m in one year. But it also has HK$2.00b in cash to offset that, meaning it has HK$570.4m net cash.

How Strong Is Luk Fook Holdings (International)'s Balance Sheet?

According to the last reported balance sheet, Luk Fook Holdings (International) had liabilities of HK$3.52b due within 12 months, and liabilities of HK$473.4m due beyond 12 months. Offsetting this, it had HK$2.00b in cash and HK$506.3m in receivables that were due within 12 months. So its liabilities total HK$1.49b more than the combination of its cash and short-term receivables.

Of course, Luk Fook Holdings (International) has a market capitalization of HK$8.64b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Luk Fook Holdings (International) also has more cash than debt, so we're pretty confident it can manage its debt safely.

Also positive, Luk Fook Holdings (International) grew its EBIT by 23% in the last year, and that should make it easier to pay down debt, going forward. The balance sheet is clearly the area to focus on when you are analysing debt. 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. During the last three years, Luk Fook Holdings (International) produced sturdy free cash flow equating to 57% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While Luk Fook Holdings (International) does have more liabilities than liquid assets, it also has net cash of HK$570.4m. And we liked the look of last year's 23% year-on-year EBIT growth. So is Luk Fook Holdings (International)'s debt a risk? It doesn't seem so to us. 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. To that end, you should be aware of the 1 warning sign we've spotted with Luk Fook Holdings (International) .

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.