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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Tian An Australia Limited (ASX:TIA) does use debt in its business. But is this debt a concern to shareholders?
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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Tian An Australia's Debt?
The image below, which you can click on for greater detail, shows that at December 2020 Tian An Australia had debt of AU$84.7m, up from AU$23.0m in one year. However, because it has a cash reserve of AU$35.3m, its net debt is less, at about AU$49.4m.
How Healthy Is Tian An Australia's Balance Sheet?
We can see from the most recent balance sheet that Tian An Australia had liabilities of AU$704.0k falling due within a year, and liabilities of AU$84.7m due beyond that. Offsetting these obligations, it had cash of AU$35.3m as well as receivables valued at AU$164.0k due within 12 months. So its liabilities total AU$50.0m more than the combination of its cash and short-term receivables.
The deficiency here weighs heavily on the AU$27.7m 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. At the end of the day, Tian An Australia would probably need a major re-capitalization if its creditors were to demand repayment. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Tian An Australia 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.
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.
Not only did Tian An Australia's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost AU$2.5m at the EBIT level. Considering that alongside the liabilities mentioned above make us nervous 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$7.6m in negative free cash flow over the last year. That means it's on the risky side of things. 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. We've identified 3 warning signs with Tian An Australia (at least 2 which are concerning) , and understanding them should be part of your investment process.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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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. 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.
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