Legendary fund manager Li Lu (whom Charlie Munger once backed) once said, “The greatest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital. So it seems smart money knows that debt – which is usually involved in bankruptcies – is a very important factor when you’re assessing a company’s risk. We can see that Linekong Interactive Group Co., Ltd. (HKG:8267) uses debt in his business. But should shareholders worry about its use of debt?
What risk does debt carry?
Debt and other liabilities become risky for a business when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is when a company has to dilute shareholders at a cheap share price just to keep debt under control. By replacing dilution, however, debt can be a great tool for companies that need capital to invest in growth at high rates of return. When we look at debt levels, we first consider cash and debt levels, together.
Check out our latest analysis for Linekong Interactive Group
What is Linekong Interactive Group’s net debt?
You can click on the graph below for historical numbers, but it shows Linekong Interactive Group had 50.0 million yen in debt in December 2021, up from 100.0 million yen a year prior. But he also has 195.7 million yen in cash to make up for that, which means he has a net cash of 145.7 million yen.
A Look at Linekong Interactive Group’s Responsibilities
Zooming in on the latest balance sheet data, we can see that Linekong Interactive Group had liabilities of 142.0 million Canadian Yen due within 12 months and liabilities of 2.94 million National Yen due beyond. On the other hand, it had a cash position of 195.7 million Canadian yen and 7.92 million national yen of receivables due within one year. He can therefore boast of having 58.7 million yen more in liquid assets than total Passives.
This excess cash is a great indication that Linekong Interactive Group’s balance sheet is almost as strong as Fort Knox’s. With that in mind, one could argue that its track record means the company is capable of dealing with some adversity. Simply put, the fact that Linekong Interactive Group has more cash than debt is arguably a good indication that it can safely manage its debt. The balance sheet is clearly the area to focus on when analyzing debt. But you can’t look at debt in total isolation; since Linekong Interactive Group will need revenue to repay this debt. So, when considering debt, it is definitely worth looking at the earnings trend. Click here for an interactive preview.
Over 12 months, Linekong Interactive Group recorded a loss in EBIT and saw its revenue fall to 86 million Canadian yen, a decline of 59%. To be honest, that doesn’t bode well.
So how risky is Linekong Interactive Group?
While Linekong Interactive Group lost money in earnings before interest and tax (EBIT), it actually generated positive free cash flow of 24 million Canadian yen. So, although it is loss-making, it does not seem to have too much short-term balance sheet risk, given net cash. The next few years will be important as the company matures. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks reside on the balance sheet, far from it. For example – Linekong Interactive Group has 2 warning signs we think you should know.
If you are interested in investing in businesses that can generate profits without the burden of debt, then check out this free list of growing companies that have net cash on the balance sheet.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.