Softpower International (HKG:380) Seems To Use Debt Rather Sparingly

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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 Softpower International Limited (HKG:380) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Softpower International

How Much Debt Does Softpower International Carry?

The image below, which you can click on for greater detail, shows that Softpower International had debt of HK$45.9m at the end of June 2020, a reduction from HK$59.5m over a year. But on the other hand it also has HK$180.0m in cash, leading to a HK$134.0m net cash position.

How Strong Is Softpower International's Balance Sheet?

According to the last reported balance sheet, Softpower International had liabilities of HK$129.3m due within 12 months, and liabilities of HK$112.8m due beyond 12 months. On the other hand, it had cash of HK$180.0m and HK$121.3m worth of receivables due within a year. So it actually has HK$59.1m more liquid assets than total liabilities.

This luscious liquidity implies that Softpower International's balance sheet is sturdy like a giant sequoia tree. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Succinctly put, Softpower International boasts net cash, so it's fair to say it does not have a heavy debt load!

Even more impressive was the fact that Softpower International grew its EBIT by 762% over twelve months. That boost will make it even easier to pay down debt going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is Softpower International's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Softpower International 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 last three years, Softpower International actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While it is always sensible to investigate a company's debt, in this case Softpower International has HK$134.0m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of HK$65m, being 218% of its EBIT. The bottom line is that Softpower International's use of debt is absolutely fine. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 4 warning signs for Softpower International (1 can't be ignored) you should be aware of.

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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