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

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Topco Scientific Co.,Ltd. (TPE:5434) does carry debt. But should shareholders be worried about its use of debt?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. 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 Net 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

The latest balance sheet data shows that Topco ScientificLtd had liabilities of NT$9.10b due within a year, and liabilities of NT$1.26b falling due after 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.

Given Topco ScientificLtd has a market capitalization of NT$22.5b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Topco ScientificLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

Fortunately, Topco ScientificLtd grew its EBIT by 9.4% in the last year, making that debt load look even more manageable. 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. Over the most recent three years, Topco ScientificLtd recorded free cash flow worth 60% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

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 we don't think Topco ScientificLtd's use of debt is risky. 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. For example - Topco ScientificLtd has 1 warning sign we think you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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. 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.
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