These 4 Measures Indicate That Talkweb Information SystemLtd (SZSE:002261) Is Using Debt Extensively

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.' 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 Talkweb Information System Co.,Ltd. (SZSE:002261) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Talkweb Information SystemLtd

How Much Debt Does Talkweb Information SystemLtd Carry?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Talkweb Information SystemLtd had CN¥1.53b of debt, an increase on CN¥564.9m, over one year. However, it does have CN¥827.9m in cash offsetting this, leading to net debt of about CN¥699.2m.

A Look At Talkweb Information SystemLtd's Liabilities

According to the last reported balance sheet, Talkweb Information SystemLtd had liabilities of CN¥2.13b due within 12 months, and liabilities of CN¥489.7m due beyond 12 months. On the other hand, it had cash of CN¥827.9m and CN¥1.27b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥521.2m.

Of course, Talkweb Information SystemLtd has a market capitalization of CN¥14.8b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Talkweb Information SystemLtd has a rather high debt to EBITDA ratio of 23.0 which suggests a meaningful debt load. However, its interest coverage of 4.0 is reasonably strong, which is a good sign. One redeeming factor for Talkweb Information SystemLtd is that it turned last year's EBIT loss into a gain of CN¥14m, over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Talkweb Information SystemLtd can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Over the last year, Talkweb Information SystemLtd saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

On the face of it, Talkweb Information SystemLtd's net debt to EBITDA left us tentative about the stock, and its conversion of EBIT to free cash flow was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its level of total liabilities is a good sign, and makes us more optimistic. Once we consider all the factors above, together, it seems to us that Talkweb Information SystemLtd's debt is making it a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. 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 1 warning sign for Talkweb Information SystemLtd that you should be aware of.

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. 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.