Topsports International Holdings (HKG:6110) Seems To Use Debt Quite Sensibly

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.' 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 note that Topsports International Holdings Limited (HKG:6110) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. 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, 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 Topsports International Holdings

What Is Topsports International Holdings's Debt?

As you can see below, Topsports International Holdings had CN¥518.2m of debt at February 2022, down from CN¥1.34b a year prior. However, its balance sheet shows it holds CN¥3.19b in cash, so it actually has CN¥2.67b net cash.

How Strong Is Topsports International Holdings' Balance Sheet?

The latest balance sheet data shows that Topsports International Holdings had liabilities of CN¥4.87b due within a year, and liabilities of CN¥2.34b falling due after that. Offsetting these obligations, it had cash of CN¥3.19b as well as receivables valued at CN¥1.11b due within 12 months. So its liabilities total CN¥2.92b more than the combination of its cash and short-term receivables.

Of course, Topsports International Holdings has a market capitalization of CN¥30.7b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Topsports International Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

On the other hand, Topsports International Holdings's EBIT dived 13%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Topsports International Holdings's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Topsports International 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, Topsports International Holdings actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

We could understand if investors are concerned about Topsports International Holdings's liabilities, but we can be reassured by the fact it has has net cash of CN¥2.67b. The cherry on top was that in converted 137% of that EBIT to free cash flow, bringing in CN¥5.0b. So we don't have any problem with Topsports International Holdings's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 2 warning signs for Topsports International Holdings that you should be aware of.

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.

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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.