We Think Topsports International Holdings (HKG:6110) Can Manage Its Debt With Ease

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, Topsports International Holdings Limited (HKG:6110) does carry debt. But is this debt a concern to shareholders?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

Check out our latest analysis for Topsports International Holdings

What Is Topsports International Holdings's Debt?

As you can see below, Topsports International Holdings had CN¥833.8m of debt at August 2021, down from CN¥2.46b a year prior. But it also has CN¥2.18b in cash to offset that, meaning it has CN¥1.34b net cash.

How Healthy Is Topsports International Holdings' Balance Sheet?

We can see from the most recent balance sheet that Topsports International Holdings had liabilities of CN¥5.06b falling due within a year, and liabilities of CN¥2.40b due beyond that. Offsetting these obligations, it had cash of CN¥2.18b as well as receivables valued at CN¥1.15b due within 12 months. So its liabilities total CN¥4.13b more than the combination of its cash and short-term receivables.

Given Topsports International Holdings has a market capitalization of CN¥43.8b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. 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 top of that, Topsports International Holdings grew its EBIT by 32% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Topsports International Holdings can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Topsports International 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. 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 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 Topsports International Holdings has CN¥1.34b in net cash. The cherry on top was that in converted 124% of that EBIT to free cash flow, bringing in CN¥4.6b. So we don't think Topsports International Holdings's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 1 warning sign 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.

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

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.