Stock Analysis

Here's Why Top Glove Corporation Bhd (KLSE:TOPGLOV) Can Manage Its Debt Responsibly

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David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. Importantly, Top Glove Corporation Bhd. (KLSE:TOPGLOV) does carry debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

Our analysis indicates that TOPGLOV is potentially undervalued!

What Is Top Glove Corporation Bhd's Debt?

You can click the graphic below for the historical numbers, but it shows that Top Glove Corporation Bhd had RM399.1m of debt in August 2022, down from RM458.7m, one year before. But it also has RM950.4m in cash to offset that, meaning it has RM551.3m net cash.

KLSE:TOPGLOV Debt to Equity History October 31st 2022

How Healthy Is Top Glove Corporation Bhd's Balance Sheet?

The latest balance sheet data shows that Top Glove Corporation Bhd had liabilities of RM941.8m due within a year, and liabilities of RM318.9m falling due after that. Offsetting this, it had RM950.4m in cash and RM468.7m in receivables that were due within 12 months. So it can boast RM158.5m more liquid assets than total liabilities.

This short term liquidity is a sign that Top Glove Corporation Bhd could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Top Glove Corporation Bhd boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that Top Glove Corporation Bhd's load is not too heavy, because its EBIT was down 96% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Top Glove Corporation Bhd'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Top Glove Corporation Bhd 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. During the last three years, Top Glove Corporation Bhd produced sturdy free cash flow equating to 67% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While it is always sensible to investigate a company's debt, in this case Top Glove Corporation Bhd has RM551.3m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of -RM783m, being 67% of its EBIT. So we are not troubled with Top Glove Corporation Bhd's debt use. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 2 warning signs for Top Glove Corporation Bhd that you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

Valuation is complex, but we're helping make it simple.

Find out whether Top Glove Corporation Bhd is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

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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.