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 Technovator International Limited (HKG:1206) makes use of debt. But the more important question is: how much risk is that debt creating?
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. 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. 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.
How Much Debt Does Technovator International Carry?
As you can see below, Technovator International had CN¥161.3m of debt at June 2020, down from CN¥280.4m a year prior. But on the other hand it also has CN¥401.3m in cash, leading to a CN¥240.0m net cash position.
A Look At Technovator International's Liabilities
According to the last reported balance sheet, Technovator International had liabilities of CN¥1.82b due within 12 months, and liabilities of CN¥41.7m due beyond 12 months. Offsetting this, it had CN¥401.3m in cash and CN¥2.03b in receivables that were due within 12 months. So it actually has CN¥570.0m more liquid assets than total liabilities.
This surplus strongly suggests that Technovator International has a rock-solid balance sheet (and the debt is of no concern whatsoever). With this in mind one could posit that its balance sheet is as strong as beautiful a rare rhino. Succinctly put, Technovator International boasts net cash, so it's fair to say it does not have a heavy debt load!
In fact Technovator International's saving grace is its low debt levels, because its EBIT has tanked 64% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Technovator International's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. Technovator International 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, Technovator International recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.
While it is always sensible to investigate a company's debt, in this case Technovator International has CN¥240.0m in net cash and a strong balance sheet. So we don't have any problem with Technovator International's use of debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Like risks, for instance. Every company has them, and we've spotted 4 warning signs for Technovator International (of which 1 is a bit unpleasant!) you should know about.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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