These 4 Measures Indicate That Theme International Holdings (HKG:990) Is Using Debt Safely

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.' 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. We note that Theme International Holdings Limited (HKG:990) does have debt on its balance sheet. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Theme International Holdings

What Is Theme International Holdings's Debt?

As you can see below, at the end of December 2022, Theme International Holdings had HK$165.6m of debt, up from HK$38.7m a year ago. Click the image for more detail. But on the other hand it also has HK$4.14b in cash, leading to a HK$3.98b net cash position.

A Look At Theme International Holdings' Liabilities

Zooming in on the latest balance sheet data, we can see that Theme International Holdings had liabilities of HK$7.67b due within 12 months and liabilities of HK$36.7m due beyond that. Offsetting this, it had HK$4.14b in cash and HK$5.18b in receivables that were due within 12 months. So it actually has HK$1.61b more liquid assets than total liabilities.

This short term liquidity is a sign that Theme International Holdings could probably pay off its debt with ease, as its balance sheet is far from stretched. 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.

In addition to that, we're happy to report that Theme International Holdings has boosted its EBIT by 30%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Theme International Holdings 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, a company can only pay off debt with cold hard cash, not accounting profits. Theme International Holdings 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, Theme International Holdings actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Theme International Holdings has net cash of HK$3.98b, as well as more liquid assets than liabilities. The cherry on top was that in converted 519% of that EBIT to free cash flow, bringing in HK$6.6b. So we don't think Theme International Holdings's use of debt is risky. Another factor that would give us confidence in Theme International Holdings would be if insiders have been buying shares: if you're conscious of that signal too, you can find out instantly by clicking this link.

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.

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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.