These 4 Measures Indicate That Ten Pao Group Holdings (HKG:1979) Is Using Debt Reasonably Well

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. We can see that Ten Pao Group Holdings Limited (HKG:1979) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Ten Pao Group Holdings

How Much Debt Does Ten Pao Group Holdings Carry?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 Ten Pao Group Holdings had HK$318.2m of debt, an increase on HK$162.0m, over one year. However, it does have HK$441.6m in cash offsetting this, leading to net cash of HK$123.4m.

How Strong Is Ten Pao Group Holdings' Balance Sheet?

According to the last reported balance sheet, Ten Pao Group Holdings had liabilities of HK$2.40b due within 12 months, and liabilities of HK$233.3m due beyond 12 months. Offsetting this, it had HK$441.6m in cash and HK$1.18b in receivables that were due within 12 months. So it has liabilities totalling HK$1.01b more than its cash and near-term receivables, combined.

This deficit isn't so bad because Ten Pao Group Holdings is worth HK$2.07b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Despite its noteworthy liabilities, Ten Pao Group Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Ten Pao Group Holdings grew its EBIT by 80% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Ten Pao Group Holdings can strengthen its balance sheet over time. 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. Ten Pao Group Holdings 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. During the last three years, Ten Pao Group Holdings produced sturdy free cash flow equating to 57% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

Although Ten Pao Group Holdings's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of HK$123.4m. And it impressed us with its EBIT growth of 80% over the last year. So is Ten Pao Group Holdings's debt a risk? It doesn't seem so to us. 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 - Ten Pao Group Holdings has 2 warning signs we think 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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