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. Importantly, Texwinca Holdings Limited (HKG:321) does carry debt. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
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. 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, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
View our latest analysis for Texwinca Holdings
What Is Texwinca Holdings's Net Debt?
As you can see below, Texwinca Holdings had HK$133.5m of debt at September 2020, down from HK$1.36b a year prior. However, it does have HK$1.13b in cash offsetting this, leading to net cash of HK$993.2m.
How Healthy Is Texwinca Holdings's Balance Sheet?
We can see from the most recent balance sheet that Texwinca Holdings had liabilities of HK$2.21b falling due within a year, and liabilities of HK$388.1m due beyond that. On the other hand, it had cash of HK$1.13b and HK$1.23b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$246.6m.
Since publicly traded Texwinca Holdings shares are worth a total of HK$2.02b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Texwinca Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!
It is just as well that Texwinca Holdings's load is not too heavy, because its EBIT was down 52% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Texwinca Holdings's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Texwinca 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. Over the last three years, Texwinca Holdings actually produced more free cash flow than EBIT. 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 Texwinca Holdings'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$993.2m. The cherry on top was that in converted 133% of that EBIT to free cash flow, bringing in HK$578m. So we don't have any problem with Texwinca Holdings's use of debt. 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. Case in point: We've spotted 3 warning signs for Texwinca Holdings you should be aware of.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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About SEHK:321
Texwinca Holdings
Engages in the production, dyeing, and sale of knitted fabrics, yarns, and garments in Hong Kong, the United States, Mainland China, Japan, and internationally.
Proven track record with mediocre balance sheet.