We Think Topco ScientificLtd (TPE:5434) Can Stay On Top Of Its Debt

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. Importantly, Topco Scientific Co.,Ltd. (TPE:5434) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 Topco ScientificLtd

What Is Topco ScientificLtd's Debt?

As you can see below, at the end of September 2020, Topco ScientificLtd had NT$2.24b of debt, up from NT$1.60b a year ago. Click the image for more detail. However, it does have NT$3.26b in cash offsetting this, leading to net cash of NT$1.02b.

A Look At Topco ScientificLtd's Liabilities

Zooming in on the latest balance sheet data, we can see that Topco ScientificLtd had liabilities of NT$9.10b due within 12 months and liabilities of NT$1.26b due beyond that. Offsetting these obligations, it had cash of NT$3.26b as well as receivables valued at NT$6.34b due within 12 months. So its liabilities total NT$762.1m more than the combination of its cash and short-term receivables.

Since publicly traded Topco ScientificLtd shares are worth a total of NT$22.3b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Topco ScientificLtd also has more cash than debt, so we're pretty confident it can manage its debt safely.

The good news is that Topco ScientificLtd has increased its EBIT by 9.4% over twelve months, which should ease any concerns about debt repayment. 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 Topco ScientificLtd'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 Topco ScientificLtd 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, Topco ScientificLtd produced sturdy free cash flow equating to 60% 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 look at a company's total liabilities, it is very reassuring that Topco ScientificLtd has NT$1.02b in net cash. So is Topco ScientificLtd's debt a risk? It doesn't seem so to us. 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 1 warning sign for Topco ScientificLtd 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.

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