Texhong Textile Group (HKG:2678) Has A Pretty Healthy Balance Sheet
The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. Importantly, Texhong Textile Group Limited (HKG:2678) does carry debt. But is this debt a concern to shareholders?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
View our latest analysis for Texhong Textile Group
How Much Debt Does Texhong Textile Group Carry?
The chart below, which you can click on for greater detail, shows that Texhong Textile Group had CN¥7.24b in debt in December 2021; about the same as the year before. However, it also had CN¥2.51b in cash, and so its net debt is CN¥4.74b.
How Healthy Is Texhong Textile Group's Balance Sheet?
We can see from the most recent balance sheet that Texhong Textile Group had liabilities of CN¥10.1b falling due within a year, and liabilities of CN¥3.75b due beyond that. Offsetting these obligations, it had cash of CN¥2.51b as well as receivables valued at CN¥2.65b due within 12 months. So it has liabilities totalling CN¥8.69b more than its cash and near-term receivables, combined.
Given this deficit is actually higher than the company's market capitalization of CN¥7.03b, we think shareholders really should watch Texhong Textile Group's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.
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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Texhong Textile Group's net debt is only 1.1 times its EBITDA. And its EBIT covers its interest expense a whopping 21.2 times over. So we're pretty relaxed about its super-conservative use of debt. Better yet, Texhong Textile Group grew its EBIT by 331% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Texhong Textile Group 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the most recent three years, Texhong Textile Group recorded free cash flow worth 56% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.
Our View
Texhong Textile Group's interest cover was a real positive on this analysis, as was its EBIT growth rate. But truth be told its level of total liabilities had us nibbling our nails. When we consider all the elements mentioned above, it seems to us that Texhong Textile Group is managing its debt quite well. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that Texhong Textile Group is showing 3 warning signs in our investment analysis , and 1 of those is a bit concerning...
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.
About SEHK:2678
Texhong International Group
An investment holding company, primarily manufactures and sells yarns, grey fabrics, and non-woven and garment fabrics.
Undervalued with excellent balance sheet.