Tibet Urban Development and InvestmentLTD (SHSE:600773) Takes On Some Risk With Its Use Of Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Tibet Urban Development and Investment Co.,LTD (SHSE:600773) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Tibet Urban Development and InvestmentLTD

How Much Debt Does Tibet Urban Development and InvestmentLTD Carry?

As you can see below, Tibet Urban Development and InvestmentLTD had CN¥3.78b of debt at March 2024, down from CN¥5.21b a year prior. On the flip side, it has CN¥1.46b in cash leading to net debt of about CN¥2.32b.

A Look At Tibet Urban Development and InvestmentLTD's Liabilities

According to the last reported balance sheet, Tibet Urban Development and InvestmentLTD had liabilities of CN¥7.19b due within 12 months, and liabilities of CN¥3.72b due beyond 12 months. Offsetting this, it had CN¥1.46b in cash and CN¥107.1m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥9.34b.

This deficit is considerable relative to its market capitalization of CN¥11.8b, 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 measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

As it happens Tibet Urban Development and InvestmentLTD has a fairly concerning net debt to EBITDA ratio of 9.1 but very strong interest coverage of 163. So either it has access to very cheap long term debt or that interest expense is going to grow! Importantly, Tibet Urban Development and InvestmentLTD's EBIT fell a jaw-dropping 43% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. 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 Tibet Urban Development and InvestmentLTD 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Tibet Urban Development and InvestmentLTD recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Our View

On the face of it, Tibet Urban Development and InvestmentLTD's net debt to EBITDA 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. But at least it's pretty decent at covering its interest expense with its EBIT; that's encouraging. We're quite clear that we consider Tibet Urban Development and InvestmentLTD to be really rather risky, as a result of its balance sheet health. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. 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. Case in point: We've spotted 3 warning signs for Tibet Urban Development and InvestmentLTD you should be aware of, and 2 of them are a bit unpleasant.

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.