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. As with many other companies Theme International Holdings Limited (HKG:990) makes use of debt. 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. 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. 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 Theme International Holdings's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2024 Theme International Holdings had debt of HK$344.1m, up from HK$4.87m in one year. But it also has HK$6.12b in cash to offset that, meaning it has HK$5.77b net cash.

How Healthy Is Theme International Holdings' Balance Sheet?

We can see from the most recent balance sheet that Theme International Holdings had liabilities of HK$10.5b falling due within a year, and liabilities of HK$25.2m due beyond that. On the other hand, it had cash of HK$6.12b and HK$5.40b worth of receivables due within a year. So it actually has HK$1.00b more liquid assets than total liabilities.

This short term liquidity is a sign that Theme International Holdings could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Theme International Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

But the other side of the story is that Theme International Holdings saw its EBIT decline by 2.1% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Theme International Holdings 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, a company can only pay off debt with cold hard cash, not accounting profits. While Theme International 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. Over the last three years, Theme International Holdings actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While it is always sensible to investigate a company's debt, in this case Theme International Holdings has HK$5.77b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of HK$4.2b, being 455% of its EBIT. So is Theme International Holdings's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 4 warning signs for Theme International Holdings that you should be aware of before investing here.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.