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.’ 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 Topco Technologies Corp. (GTSM:3388) does use debt in its business. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Topco Technologies’s Net Debt?
The image below, which you can click on for greater detail, shows that at September 2020 Topco Technologies had debt of NT$159.0m, up from NT$146.4m in one year. But it also has NT$1.60b in cash to offset that, meaning it has NT$1.44b net cash.
A Look At Topco Technologies’ Liabilities
Zooming in on the latest balance sheet data, we can see that Topco Technologies had liabilities of NT$1.22b due within 12 months and liabilities of NT$145.5m due beyond that. On the other hand, it had cash of NT$1.60b and NT$2.14b worth of receivables due within a year. So it actually has NT$2.38b more liquid assets than total liabilities.
This excess liquidity is a great indication that Topco Technologies’ balance sheet is almost as strong as Fort Knox. With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Simply put, the fact that Topco Technologies has more cash than debt is arguably a good indication that it can manage its debt safely.
But the other side of the story is that Topco Technologies saw its EBIT decline by 5.0% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. When analysing debt levels, the balance sheet is the obvious place to start. But you can’t view debt in total isolation; since Topco Technologies will need earnings to service that debt. So when considering debt, it’s definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Topco Technologies 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 Technologies recorded free cash flow worth 69% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
While it is always sensible to investigate a company’s debt, in this case Topco Technologies has NT$1.44b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 69% of that EBIT to free cash flow, bringing in NT$327m. So is Topco Technologies’s debt a risk? It doesn’t seem so to us. There’s no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we’ve spotted 1 warning sign for Topco Technologies you should know about.
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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Read More: These 4 Measures Indicate That Topco Technologies (GTSM:3388) Is Using Debt Safely