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.' 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. We can see that TOM Group Limited (HKG:2383) does use debt in its business. But the more important question is: how much risk is that debt creating?
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. If things get really bad, the lenders can take control of the business. 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.
How Much Debt Does TOM Group Carry?
The chart below, which you can click on for greater detail, shows that TOM Group had HK$2.92b in debt in December 2018; about the same as the year before. However, it also had HK$386.1m in cash, and so its net debt is HK$2.54b.
A Look At TOM Group's Liabilities
Zooming in on the latest balance sheet data, we can see that TOM Group had liabilities of HK$682.6m due within 12 months and liabilities of HK$2.89b due beyond that. On the other hand, it had cash of HK$386.1m and HK$275.0m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$2.91b.
TOM Group has a market capitalization of HK$6.21b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since TOM Group will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Over 12 months, TOM Group saw its revenue hold pretty steady. While that hardly impresses, its not too bad either.
Over the last twelve months TOM Group produced an earnings before interest and tax (EBIT) loss. To be specific the EBIT loss came in at HK$13m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled HK$65m in negative free cash flow over the last twelve months. So to be blunt we think it is risky. When we look at a riskier company, we like to check how their profits (or losses) are trending over time. Today, we're providing readers this interactive graph showing how TOM Group's profit, revenue, and operating cashflow have changed over the last few years.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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