Does Softpower International (HKG:380) Have A Healthy Balance Sheet?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Softpower International Limited (HKG:380) does carry debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. 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 Softpower International

What Is Softpower International's Net Debt?

The image below, which you can click on for greater detail, shows that at December 2020 Softpower International had debt of HK$57.0m, up from HK$47.4m in one year. But on the other hand it also has HK$246.8m in cash, leading to a HK$189.8m net cash position.

How Healthy Is Softpower International's Balance Sheet?

According to the last reported balance sheet, Softpower International had liabilities of HK$152.5m due within 12 months, and liabilities of HK$102.0m due beyond 12 months. Offsetting this, it had HK$246.8m in cash and HK$127.5m in receivables that were due within 12 months. So it can boast HK$119.8m more liquid assets than total liabilities.

This luscious liquidity implies that Softpower International's balance sheet is sturdy like a giant sequoia tree. Having regard to this fact, we think its balance sheet is as strong as an ox. Succinctly put, Softpower International boasts net cash, so it's fair to say it does not have a heavy debt load!

Pleasingly, Softpower International is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 969% gain in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Softpower International 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Softpower 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. Happily for any shareholders, Softpower International actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Softpower International has net cash of HK$189.8m, as well as more liquid assets than liabilities. The cherry on top was that in converted 245% of that EBIT to free cash flow, bringing in HK$65m. When it comes to Softpower International's debt, we sufficiently relaxed that our mind turns to the jacuzzi. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 3 warning signs for Softpower International you should be aware of, and 1 of them is significant.

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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