Tomson Group (HKG:258) Has A Somewhat Strained Balance Sheet

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Tomson Group Limited (HKG:258) makes use of 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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Tomson Group

What Is Tomson Group's Debt?

As you can see below, Tomson Group had HK$1.02b of debt at December 2020, down from HK$1.29b a year prior. But it also has HK$3.81b in cash to offset that, meaning it has HK$2.80b net cash.

How Healthy Is Tomson Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Tomson Group had liabilities of HK$5.63b due within 12 months and liabilities of HK$1.54b due beyond that. On the other hand, it had cash of HK$3.81b and HK$298.0m worth of receivables due within a year. So its liabilities total HK$3.06b more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of HK$4.04b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. Despite its noteworthy liabilities, Tomson Group boasts net cash, so it's fair to say it does not have a heavy debt load!

On the other hand, Tomson Group's EBIT dived 14%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. There's no doubt that we learn most about debt from the balance sheet. 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. 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

Although Tomson Group'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$2.80b. Despite its cash we think that Tomson Group seems to struggle to convert EBIT to free cash flow, so we are wary of the stock. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Tomson Group (of which 1 is a bit unpleasant!) you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

If you decide to trade Tomson Group, use the lowest-cost* platform that is rated #1 Overall by Barron’s, Interactive Brokers. Trade stocks, options, futures, forex, bonds and funds on 135 markets, all from a single integrated account. Promoted

This article by Simply Wall St is general in nature. 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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

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