Is Tangrenshen Group (SZSE:002567) Using Debt Sensibly?

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. As with many other companies Tangrenshen Group Co., Ltd (SZSE:002567) makes use of debt. But should shareholders be worried about its use of debt?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Tangrenshen Group

What Is Tangrenshen Group's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Tangrenshen Group had CN¥7.62b of debt, an increase on CN¥6.80b, over one year. On the flip side, it has CN¥2.47b in cash leading to net debt of about CN¥5.15b.

How Strong Is Tangrenshen Group's Balance Sheet?

We can see from the most recent balance sheet that Tangrenshen Group had liabilities of CN¥5.91b falling due within a year, and liabilities of CN¥5.97b due beyond that. Offsetting this, it had CN¥2.47b in cash and CN¥676.9m in receivables that were due within 12 months. So it has liabilities totalling CN¥8.74b more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of CN¥7.89b, we think shareholders really should watch Tangrenshen Group's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Tangrenshen Group's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Over 12 months, Tangrenshen Group made a loss at the EBIT level, and saw its revenue drop to CN¥25b, which is a fall of 10%. That's not what we would hope to see.

Caveat Emptor

Not only did Tangrenshen Group's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost a very considerable CN¥1.0b 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 CN¥186m 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. However, not all investment risk resides within the balance sheet - far from it. We've identified 1 warning sign with Tangrenshen Group , and understanding them should be part of your investment process.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com