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 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 can see that Top Global Limited (SGX:BHO) does use debt in its business. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of ‘creative destruction’ where failed businesses are mercilessly liquidated by their bankers. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company’s debt levels is to consider its cash and debt together.
See our latest analysis for Top Global
What Is Top Global’s Net Debt?
The image below, which you can click on for greater detail, shows that at December 2019 Top Global had debt of S$148.0m, up from S$19.0m in one year. However, it does have S$18.3m in cash offsetting this, leading to net debt of about S$129.7m.
How Strong Is Top Global’s Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Top Global had liabilities of S$50.2m due within 12 months and liabilities of S$147.5m due beyond that. On the other hand, it had cash of S$18.3m and S$4.64m worth of receivables due within a year. So it has liabilities totalling S$174.8m more than its cash and near-term receivables, combined.
This deficit casts a shadow over the S$55.0m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Top Global would probably need a major re-capitalization if its creditors were to demand repayment. There’s no doubt that we learn most about debt from the balance sheet. But it is Top Global’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.
Over 12 months, Top Global made a loss at the EBIT level, and saw its revenue drop to S$58m, which is a fall of 27%. That makes us nervous, to say the least.
Caveat Emptor
Not only did Top Global’s revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). To be specific the EBIT loss came in at S$5.4m. If you consider the significant liabilities mentioned above, we are extremely wary of this investment. That said, it is possible that the company will turn its fortunes around. But on the bright side the company actually produced a statutory profit of S$551k and free cash flow of S$663k. So one might argue that there’s still a chance it can get things on the right track. 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. Consider for instance, the ever-present spectre of investment risk. We’ve identified 2 warning signs with Top Global , and understanding them should be part of your investment process.
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.
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.
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