Here's Why Tu Yi Holding (HKG:1701) Can Afford Some Debt

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 Tu Yi Holding Company Limited (HKG:1701) does use debt in its business. But is this debt a concern to shareholders?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

See our latest analysis for Tu Yi Holding

What Is Tu Yi Holding's Debt?

As you can see below, at the end of December 2020, Tu Yi Holding had CN¥67.2m of debt, up from CN¥59.4m a year ago. Click the image for more detail. However, it does have CN¥47.0m in cash offsetting this, leading to net debt of about CN¥20.1m.

How Strong Is Tu Yi Holding's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Tu Yi Holding had liabilities of CN¥41.2m due within 12 months and liabilities of CN¥47.2m due beyond that. Offsetting this, it had CN¥47.0m in cash and CN¥1.83m in receivables that were due within 12 months. So its liabilities total CN¥39.5m more than the combination of its cash and short-term receivables.

Of course, Tu Yi Holding has a market capitalization of CN¥212.5m, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. There's no doubt that we learn most about debt from the balance sheet. But it is Tu Yi Holding's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year Tu Yi Holding had a loss before interest and tax, and actually shrunk its revenue by 87%, to CN¥31m. To be frank that doesn't bode well.

Caveat Emptor

While Tu Yi Holding's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Its EBIT loss was a whopping CN¥50m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. For example, we would not want to see a repeat of last year's loss of CN¥45m. So we do think this stock is quite risky. 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. Be aware that Tu Yi Holding is showing 4 warning signs in our investment analysis , and 1 of those can't be ignored...

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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