Is Tomson Group (HKG:258) A Risky Investment?

Simply Wall St
November 22, 2021
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Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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, Tomson Group Limited (HKG:258) does carry debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Tomson Group

What Is Tomson Group's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Tomson Group had HK$317.0m of debt in June 2021, down from HK$1.01b, one year before. But it also has HK$3.98b in cash to offset that, meaning it has HK$3.66b net cash.

SEHK:258 Debt to Equity History November 22nd 2021

How Strong Is Tomson Group's Balance Sheet?

We can see from the most recent balance sheet that Tomson Group had liabilities of HK$4.76b falling due within a year, and liabilities of HK$1.54b due beyond that. Offsetting this, it had HK$3.98b in cash and HK$287.0m in receivables that were due within 12 months. So it has liabilities totalling HK$2.04b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Tomson Group has a market capitalization of HK$4.14b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. Despite its noteworthy liabilities, Tomson Group boasts net cash, so it's fair to say it does not have a heavy debt load!

Even more impressive was the fact that Tomson Group grew its EBIT by 105% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Tomson Group'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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Tomson Group 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. During the last three years, Tomson Group burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing up

While Tomson Group does have more liabilities than liquid assets, it also has net cash of HK$3.66b. And it impressed us with its EBIT growth of 105% over the last year. So we don't have any problem with Tomson Group's use of debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 2 warning signs we've spotted with Tomson Group (including 1 which is significant) .

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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