We Think EEKA Fashion Holdings (HKG:3709) Can Manage Its Debt With Ease

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, EEKA Fashion Holdings Limited (HKG:3709) does carry debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for EEKA Fashion Holdings

What Is EEKA Fashion Holdings's Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2020 EEKA Fashion Holdings had CN¥540.8m of debt, an increase on CN¥310.5m, over one year. But it also has CN¥1.15b in cash to offset that, meaning it has CN¥607.2m net cash.

How Healthy Is EEKA Fashion Holdings's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that EEKA Fashion Holdings had liabilities of CN¥1.87b due within 12 months and liabilities of CN¥560.0m due beyond that. On the other hand, it had cash of CN¥1.15b and CN¥463.6m worth of receivables due within a year. So it has liabilities totalling CN¥815.7m more than its cash and near-term receivables, combined.

Since publicly traded EEKA Fashion Holdings shares are worth a total of CN¥9.33b, 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, EEKA Fashion Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that EEKA Fashion Holdings has boosted its EBIT by 45%, thus reducing the spectre of future debt repayments. 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 EEKA Fashion 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. EEKA Fashion 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, EEKA Fashion Holdings actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

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¥607.2m in net cash. And it impressed us with free cash flow of CN¥984m, being 160% of its EBIT. So we don't think EEKA Fashion Holdings's use of debt is risky. 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. Case in point: We've spotted 1 warning sign for EEKA Fashion Holdings you should be aware of.

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. 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.
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