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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Theme International Holdings Limited (HKG:990) does carry debt. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
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. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Theme International Holdings's Net Debt?
The image below, which you can click on for greater detail, shows that at June 2021 Theme International Holdings had debt of HK$1.26b, up from HK$808.4m in one year. But it also has HK$2.13b in cash to offset that, meaning it has HK$874.5m net cash.
A Look At Theme International Holdings' Liabilities
According to the last reported balance sheet, Theme International Holdings had liabilities of HK$5.44b due within 12 months, and liabilities of HK$3.66m due beyond 12 months. Offsetting these obligations, it had cash of HK$2.13b as well as receivables valued at HK$3.47b due within 12 months. So it actually has HK$156.6m more liquid assets than total liabilities.
This state of affairs indicates that Theme International Holdings' balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the HK$10.4b company is struggling for cash, we still think it's worth monitoring its balance sheet. Simply put, the fact that Theme International Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.
Better yet, Theme International Holdings grew its EBIT by 197% last year, which is an impressive improvement. 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 Theme International Holdings'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 Theme International Holdings 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, Theme International Holdings actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.
While we empathize with investors who find debt concerning, you should keep in mind that Theme International Holdings has net cash of HK$874.5m, as well as more liquid assets than liabilities. The cherry on top was that in converted 972% of that EBIT to free cash flow, bringing in HK$2.0b. So is Theme International Holdings's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 2 warning signs for Theme International Holdings you should be aware of.
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.
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.
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