Stock Analysis

We Think Top Glove Corporation Bhd (KLSE:TOPGLOV) Can Stay On Top Of Its Debt

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The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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, Top Glove Corporation Bhd. (KLSE:TOPGLOV) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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, 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.

Check out our latest analysis for Top Glove Corporation Bhd

How Much Debt Does Top Glove Corporation Bhd Carry?

You can click the graphic below for the historical numbers, but it shows that Top Glove Corporation Bhd had RM440.8m of debt in May 2022, down from RM482.8m, one year before. However, its balance sheet shows it holds RM1.00b in cash, so it actually has RM562.9m net cash.

KLSE:TOPGLOV Debt to Equity History July 18th 2022

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

Zooming in on the latest balance sheet data, we can see that Top Glove Corporation Bhd had liabilities of RM1.28b due within 12 months and liabilities of RM332.5m due beyond that. Offsetting these obligations, it had cash of RM1.00b as well as receivables valued at RM709.6m due within 12 months. So it actually has RM101.2m more liquid assets than total liabilities.

Having regard to Top Glove Corporation Bhd's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the RM8.33b company is struggling for cash, we still think it's worth monitoring its balance sheet. Simply put, the fact that Top Glove Corporation Bhd has more cash than debt is arguably a good indication that it can manage its debt safely.

The modesty of its debt load may become crucial for Top Glove Corporation Bhd if management cannot prevent a repeat of the 92% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. 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 Top Glove Corporation Bhd'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 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. Over the most recent three years, Top Glove Corporation Bhd recorded free cash flow worth 67% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Top Glove Corporation Bhd has net cash of RM562.9m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of -RM1.5b, being 67% of its EBIT. So we don't have any problem with Top Glove Corporation Bhd'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. Case in point: We've spotted 5 warning signs for Top Glove Corporation Bhd you should be aware of, and 1 of them can't be ignored.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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.