Tongkun Group (SHSE:601233) Has Debt But No Earnings; Should You Worry?

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 Tongkun Group Co., Ltd. (SHSE:601233) does use debt in its business. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest 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.

View our latest analysis for Tongkun Group

What Is Tongkun Group's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2023 Tongkun Group had debt of CN¥56.2b, up from CN¥42.7b in one year. However, it also had CN¥19.9b in cash, and so its net debt is CN¥36.3b.

How Healthy Is Tongkun Group's Balance Sheet?

We can see from the most recent balance sheet that Tongkun Group had liabilities of CN¥50.1b falling due within a year, and liabilities of CN¥21.0b due beyond that. Offsetting these obligations, it had cash of CN¥19.9b as well as receivables valued at CN¥1.32b due within 12 months. So it has liabilities totalling CN¥49.8b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the CN¥31.7b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Tongkun Group would probably need a major re-capitalization if its creditors were to demand repayment. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Tongkun Group can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

In the last year Tongkun Group wasn't profitable at an EBIT level, but managed to grow its revenue by 37%, to CN¥77b. Shareholders probably have their fingers crossed that it can grow its way to profits.

Caveat Emptor

Despite the top line growth, Tongkun Group still had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost CN¥381m 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¥6.0b in negative free cash flow over the last year. That means it's on the risky side of things. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Be aware that Tongkun Group is showing 1 warning sign in our investment analysis , you should know about...

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.