We Think EEKA Fashion Holdings (HKG:3709) Can Manage Its Debt With Ease

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that EEKA Fashion Holdings Limited (HKG:3709) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for EEKA Fashion Holdings

How Much Debt Does EEKA Fashion Holdings Carry?

As you can see below, at the end of June 2019, EEKA Fashion Holdings had CN¥310.5m of debt, up from CN¥187.2m a year ago. Click the image for more detail. But it also has CN¥833.1m in cash to offset that, meaning it has CN¥522.6m net cash.

How Strong Is EEKA Fashion Holdings's Balance Sheet?

We can see from the most recent balance sheet that EEKA Fashion Holdings had liabilities of CN¥684.7m falling due within a year, and liabilities of CN¥132.5m due beyond that. Offsetting these obligations, it had cash of CN¥833.1m as well as receivables valued at CN¥279.0m due within 12 months. So it can boast CN¥294.9m more liquid assets than total liabilities.

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

While EEKA Fashion Holdings doesn't seem to have gained much on the EBIT line, at least earnings remain stable for now. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since EEKA Fashion 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. EEKA Fashion Holdings may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, EEKA Fashion Holdings produced sturdy free cash flow equating to 71% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that EEKA Fashion Holdings has net cash of CN¥522.6m, as well as more liquid assets than liabilities. The cherry on top was that in converted 71% of that EBIT to free cash flow, bringing in CN¥306m. So we don't think EEKA Fashion Holdings's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for EEKA Fashion 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.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.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.

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