Is Tu Yi Holding (HKG:1701) Using Too Much Debt?

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 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. As with many other companies Tu Yi Holding Company Limited (HKG:1701) makes use of debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Tu Yi Holding

What Is Tu Yi Holding's Net Debt?

As you can see below, Tu Yi Holding had CN¥56.4m of debt, at June 2023, which is about the same as the year before. You can click the chart for greater detail. However, because it has a cash reserve of CN¥34.5m, its net debt is less, at about CN¥21.9m.

A Look At Tu Yi Holding's Liabilities

We can see from the most recent balance sheet that Tu Yi Holding had liabilities of CN¥48.2m falling due within a year, and liabilities of CN¥36.0m due beyond that. Offsetting these obligations, it had cash of CN¥34.5m as well as receivables valued at CN¥5.27m due within 12 months. So it has liabilities totalling CN¥44.4m more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Tu Yi Holding has a market capitalization of CN¥136.3m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Tu Yi Holding will need earnings to service that debt. 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.

Over 12 months, Tu Yi Holding reported revenue of CN¥41m, which is a gain of 73%, although it did not report any earnings before interest and tax. With any luck the company will be able to grow its way to profitability.

Caveat Emptor

Despite the top line growth, Tu Yi Holding still had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost CN¥8.5m at the EBIT level. 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. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. For example, we would not want to see a repeat of last year's loss of CN¥12m. So we do think this stock is quite risky. 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. To that end, you should learn about the 2 warning signs we've spotted with Tu Yi Holding (including 1 which shouldn't be ignored) .

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. 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.