Is Tian An Australia (ASX:TIA) Using Debt In A Risky Way?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 note that Tian An Australia Limited (ASX:TIA) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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.

View our latest analysis for Tian An Australia

What Is Tian An Australia's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2021 Tian An Australia had debt of AU$88.2m, up from AU$72.7m in one year. However, it does have AU$31.1m in cash offsetting this, leading to net debt of about AU$57.1m.

A Look At Tian An Australia's Liabilities

According to the last reported balance sheet, Tian An Australia had liabilities of AU$88.9m due within 12 months, and liabilities of AU$168.0k due beyond 12 months. Offsetting this, it had AU$31.1m in cash and AU$210.0k in receivables that were due within 12 months. So it has liabilities totalling AU$57.8m more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the AU$26.8m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, Tian An Australia would likely require a major re-capitalisation if it had to pay its creditors today. There's no doubt that we learn most about debt from the balance sheet. But it is Tian An Australia's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

It seems likely shareholders hope that Tian An Australia can significantly advance the business plan before too long, because it doesn't have any significant revenue at the moment.

Caveat Emptor

Importantly, Tian An Australia had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost a very considerable AU$2.7m at the EBIT level. When we look at that alongside the significant liabilities, we're not particularly confident about the company. It would need to improve its operations quickly for us to be interested in it. Not least because it burned through AU$7.2m in negative free cash flow over the last year. That means it's on the risky side of things. 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. For instance, we've identified 4 warning signs for Tian An Australia (3 shouldn't be ignored) you should be aware of.

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.

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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.