Is TongweiLtd (SHSE:600438) Using Debt Sensibly?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Tongwei Co.,Ltd (SHSE:600438) makes use of debt. But the real question is whether this debt is making the company risky.

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. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for TongweiLtd

What Is TongweiLtd's Debt?

As you can see below, at the end of September 2024, TongweiLtd had CN¥71.6b of debt, up from CN¥38.7b a year ago. Click the image for more detail. On the flip side, it has CN¥31.1b in cash leading to net debt of about CN¥40.5b.

How Healthy Is TongweiLtd's Balance Sheet?

According to the last reported balance sheet, TongweiLtd had liabilities of CN¥63.8b due within 12 months, and liabilities of CN¥72.9b due beyond 12 months. On the other hand, it had cash of CN¥31.1b and CN¥19.9b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥85.6b.

This deficit is considerable relative to its very significant market capitalization of CN¥95.2b, so it does suggest shareholders should keep an eye on TongweiLtd's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. 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 TongweiLtd 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.

Over 12 months, TongweiLtd made a loss at the EBIT level, and saw its revenue drop to CN¥96b, which is a fall of 37%. To be frank that doesn't bode well.

Caveat Emptor

Not only did TongweiLtd's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). To be specific the EBIT loss came in at CN¥587m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled CN¥28b in negative free cash flow over the last twelve months. So in short it's a really risky stock. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for TongweiLtd you should know about.

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.