Is Thelloy Development Group (HKG:1546) Using Too Much Debt?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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. Importantly, Thelloy Development Group Limited (HKG:1546) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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.

See our latest analysis for Thelloy Development Group

What Is Thelloy Development Group's Debt?

You can click the graphic below for the historical numbers, but it shows that Thelloy Development Group had HK$15.0m of debt in March 2022, down from HK$30.0m, one year before. However, it does have HK$56.6m in cash offsetting this, leading to net cash of HK$41.6m.

How Healthy Is Thelloy Development Group's Balance Sheet?

The latest balance sheet data shows that Thelloy Development Group had liabilities of HK$118.9m due within a year, and liabilities of HK$4.66m falling due after that. On the other hand, it had cash of HK$56.6m and HK$33.5m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$33.6m.

This deficit isn't so bad because Thelloy Development Group is worth HK$121.6m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Despite its noteworthy liabilities, Thelloy Development Group boasts net cash, so it's fair to say it does not have a heavy debt load!

Although Thelloy Development Group made a loss at the EBIT level, last year, it was also good to see that it generated HK$5.2m in EBIT over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Thelloy Development Group will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Thelloy Development Group 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. Happily for any shareholders, Thelloy Development Group actually produced more free cash flow than EBIT over the last year. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

Although Thelloy Development Group'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$41.6m. And it impressed us with free cash flow of HK$27m, being 522% of its EBIT. So we are not troubled with Thelloy Development Group's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 3 warning signs we've spotted with Thelloy Development Group (including 1 which shouldn't be ignored) .

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. 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.