Is TPV Technology (SZSE:000727) A Risky Investment?

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 TPV Technology Co., Ltd. (SZSE:000727) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for TPV Technology

How Much Debt Does TPV Technology Carry?

You can click the graphic below for the historical numbers, but it shows that TPV Technology had CN¥4.31b of debt in September 2023, down from CN¥6.51b, one year before. On the flip side, it has CN¥4.09b in cash leading to net debt of about CN¥224.5m.

A Look At TPV Technology's Liabilities

We can see from the most recent balance sheet that TPV Technology had liabilities of CN¥23.6b falling due within a year, and liabilities of CN¥4.45b due beyond that. Offsetting this, it had CN¥4.09b in cash and CN¥10.9b in receivables that were due within 12 months. So it has liabilities totalling CN¥13.0b more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of CN¥11.7b, we think shareholders really should watch TPV Technology's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.

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.

With net debt at just 0.091 times EBITDA, it seems TPV Technology only uses a little bit of leverage. But EBIT was only 3.7 times the interest expense last year, so the borrowing is clearly weighing on the business somewhat. It is well worth noting that TPV Technology's EBIT shot up like bamboo after rain, gaining 45% in the last twelve months. That'll make it easier to manage its debt. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since TPV Technology will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

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, TPV Technology barely recorded positive free cash flow, in total. While many companies do operate at break-even, we prefer see substantial free cash flow, especially if a it already has dead.

Our View

We feel some trepidation about TPV Technology's difficulty conversion of EBIT to free cash flow, but we've got positives to focus on, too. To wit both its EBIT growth rate and net debt to EBITDA were encouraging signs. When we consider all the factors discussed, it seems to us that TPV Technology is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 1 warning sign for TPV Technology you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.