Is Top Form International (HKG:333) Using Too Much Debt?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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, Top Form International Limited (HKG:333) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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. 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 Top Form International

What Is Top Form International's Debt?

The image below, which you can click on for greater detail, shows that at December 2023 Top Form International had debt of HK$119.0m, up from HK$88.6m in one year. On the flip side, it has HK$98.7m in cash leading to net debt of about HK$20.3m.

A Look At Top Form International's Liabilities

We can see from the most recent balance sheet that Top Form International had liabilities of HK$374.4m falling due within a year, and liabilities of HK$57.4m due beyond that. On the other hand, it had cash of HK$98.7m and HK$236.0m worth of receivables due within a year. So its liabilities total HK$97.0m more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of HK$106.9m, so it does suggest shareholders should keep an eye on Top Form International's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. There's no doubt that we learn most about debt from the balance sheet. But it is Top Form International's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Over 12 months, Top Form International made a loss at the EBIT level, and saw its revenue drop to HK$1.0b, which is a fall of 15%. That's not what we would hope to see.

Caveat Emptor

While Top Form International's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Its EBIT loss was a whopping HK$49m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. However, it doesn't help that it burned through HK$7.1m of cash over the last year. So suffice it to say we consider the stock very risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 1 warning sign we've spotted with Top Form International .

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.