Tibet Urban Development and InvestmentLTD (SHSE:600773) Seems To Be Using A Lot Of Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. Importantly, Tibet Urban Development and Investment Co.,LTD (SHSE:600773) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Tibet Urban Development and InvestmentLTD

What Is Tibet Urban Development and InvestmentLTD's Net Debt?

The image below, which you can click on for greater detail, shows that Tibet Urban Development and InvestmentLTD had debt of CN¥3.67b at the end of September 2024, a reduction from CN¥4.05b over a year. On the flip side, it has CN¥914.5m in cash leading to net debt of about CN¥2.76b.

How Healthy Is Tibet Urban Development and InvestmentLTD's Balance Sheet?

According to the last reported balance sheet, Tibet Urban Development and InvestmentLTD had liabilities of CN¥6.37b due within 12 months, and liabilities of CN¥3.74b due beyond 12 months. Offsetting this, it had CN¥914.5m in cash and CN¥85.6m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥9.11b.

This deficit is considerable relative to its market capitalization of CN¥12.3b, so it does suggest shareholders should keep an eye on Tibet Urban Development and InvestmentLTD's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). 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).

Weak interest cover of 0.024 times and a disturbingly high net debt to EBITDA ratio of 27.1 hit our confidence in Tibet Urban Development and InvestmentLTD like a one-two punch to the gut. The debt burden here is substantial. Even worse, Tibet Urban Development and InvestmentLTD saw its EBIT tank 99% over the last 12 months. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. There's no doubt that we learn most about debt from the balance sheet. But it is Tibet Urban Development and InvestmentLTD'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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Tibet Urban Development and InvestmentLTD 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, Tibet Urban Development and InvestmentLTD's conversion of EBIT to free cash flow left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. And even its net debt to EBITDA fails to inspire much confidence. After considering the datapoints discussed, we think Tibet Urban Development and InvestmentLTD has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. 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. To that end, you should learn about the 3 warning signs we've spotted with Tibet Urban Development and InvestmentLTD (including 2 which are a bit concerning) .

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.