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.' 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 note that Texwinca Holdings Limited (HKG:321) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Texwinca Holdings's Debt?
As you can see below, Texwinca Holdings had HK$1.53b of debt, at March 2019, which is about the same the year before. You can click the chart for greater detail. But it also has HK$2.21b in cash to offset that, meaning it has HK$676.9m net cash.
How Strong Is Texwinca Holdings's Balance Sheet?
According to the last reported balance sheet, Texwinca Holdings had liabilities of HK$3.07b due within 12 months, and liabilities of HK$135.9m due beyond 12 months. Offsetting these obligations, it had cash of HK$2.21b as well as receivables valued at HK$950.5m due within 12 months. So these liquid assets roughly match the total liabilities.
This state of affairs indicates that Texwinca Holdings's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the HK$2.61b company is short on cash, but still worth keeping an eye on the balance sheet. While it does have liabilities worth noting, Texwinca Holdings also has more cash than debt, so we're pretty confident it can manage its debt safely.
Another good sign is that Texwinca Holdings has been able to increase its EBIT by 24% in twelve months, making it easier to pay down debt. 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 Texwinca Holdings'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.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Texwinca Holdings 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. Considering the last three years, Texwinca Holdings actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.
We could understand if investors are concerned about Texwinca Holdings's liabilities, but we can be reassured by the fact it has has net cash of HK$677m. And it impressed us with its EBIT growth of 24% over the last year. So we don't have any problem with Texwinca Holdings's use of debt. We'd be motivated to research the stock further if we found out that Texwinca Holdings insiders have bought shares recently. If you would too, then you're in luck, since today we're sharing our list of reported insider transactions for free.
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.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at email@example.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. Thank you for reading.