Does China Tangshang Holdings (HKG:674) Have A Healthy Balance Sheet?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that China Tangshang Holdings Limited (HKG:674) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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.

See our latest analysis for China Tangshang Holdings

What Is China Tangshang Holdings's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2020 China Tangshang Holdings had debt of HK$334.7m, up from HK$170.8m in one year. However, it does have HK$232.9m in cash offsetting this, leading to net debt of about HK$101.8m.

How Healthy Is China Tangshang Holdings' Balance Sheet?

We can see from the most recent balance sheet that China Tangshang Holdings had liabilities of HK$450.4m falling due within a year, and liabilities of HK$380.5m due beyond that. Offsetting these obligations, it had cash of HK$232.9m as well as receivables valued at HK$10.1m due within 12 months. So its liabilities total HK$587.9m more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the HK$228.6m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, China Tangshang Holdings would probably need a major re-capitalization if its creditors were to demand repayment.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

China Tangshang Holdings shareholders face the double whammy of a high net debt to EBITDA ratio (5.5), and fairly weak interest coverage, since EBIT is just 0.86 times the interest expense. This means we'd consider it to have a heavy debt load. One redeeming factor for China Tangshang Holdings is that it turned last year's EBIT loss into a gain of HK$18m, over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is China Tangshang Holdings's earnings that will influence how the balance sheet holds up in the future. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Happily for any shareholders, China Tangshang Holdings actually produced more free cash flow than EBIT over the last year. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

On the face of it, China Tangshang Holdings's interest cover left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. Looking at the bigger picture, it seems clear to us that China Tangshang Holdings's use of debt is creating risks for the company. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Take risks, for example - China Tangshang Holdings has 3 warning signs (and 1 which is potentially serious) we think you should know about.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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This article by Simply Wall St is general in nature. 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.
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