We Think Tianneng Power International (HKG:819) Is Taking Some Risk With Its Debt

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. As with many other companies Tianneng Power International Limited (HKG:819) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. 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. When we examine debt levels, we first consider both cash and debt levels, together.

Our analysis indicates that 819 is potentially undervalued!

What Is Tianneng Power International's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2022 Tianneng Power International had debt of CN¥7.62b, up from CN¥6.05b in one year. However, it does have CN¥11.9b in cash offsetting this, leading to net cash of CN¥4.30b.

How Strong Is Tianneng Power International's Balance Sheet?

We can see from the most recent balance sheet that Tianneng Power International had liabilities of CN¥21.6b falling due within a year, and liabilities of CN¥2.20b due beyond that. On the other hand, it had cash of CN¥11.9b and CN¥4.36b worth of receivables due within a year. So its liabilities total CN¥7.47b more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of CN¥8.81b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. While it does have liabilities worth noting, Tianneng Power International also has more cash than debt, so we're pretty confident it can manage its debt safely.

The modesty of its debt load may become crucial for Tianneng Power International if management cannot prevent a repeat of the 43% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Tianneng Power International's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Tianneng Power International may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Considering the last three years, Tianneng Power International actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Summing Up

Although Tianneng Power International's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥4.30b. Despite its cash we think that Tianneng Power International seems to struggle to grow its EBIT, so we are wary of the stock. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Tianneng Power International has 2 warning signs we think 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.