These 4 Measures Indicate That EEKA Fashion Holdings (HKG:3709) Is Using Debt Reasonably Well

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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that EEKA Fashion Holdings Limited (HKG:3709) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for EEKA Fashion Holdings

What Is EEKA Fashion Holdings's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2023 EEKA Fashion Holdings had debt of CN¥444.5m, up from CN¥399.7m in one year. However, its balance sheet shows it holds CN¥1.36b in cash, so it actually has CN¥911.4m net cash.

A Look At EEKA Fashion Holdings' Liabilities

According to the last reported balance sheet, EEKA Fashion Holdings had liabilities of CN¥1.79b due within 12 months, and liabilities of CN¥510.2m due beyond 12 months. Offsetting this, it had CN¥1.36b in cash and CN¥574.9m in receivables that were due within 12 months. So it has liabilities totalling CN¥366.2m more than its cash and near-term receivables, combined.

Of course, EEKA Fashion Holdings has a market capitalization of CN¥8.68b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, EEKA Fashion Holdings also has more cash than debt, so we're pretty confident it can manage its debt safely.

But the bad news is that EEKA Fashion Holdings has seen its EBIT plunge 10% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if EEKA Fashion Holdings can strengthen its balance sheet over time. 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 company can only pay off debt with cold hard cash, not accounting profits. While EEKA Fashion Holdings has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, EEKA Fashion 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 it is always sensible to look at a company's total liabilities, it is very reassuring that EEKA Fashion Holdings has CN¥911.4m in net cash. The cherry on top was that in converted 215% of that EBIT to free cash flow, bringing in CN¥1.5b. So we don't think EEKA Fashion Holdings's use of debt is risky. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that EEKA Fashion Holdings insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.