Tu Yi Holding (HKG:1701) 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. As with many other companies Tu Yi Holding Company Limited (HKG:1701) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Tu Yi Holding

How Much Debt Does Tu Yi Holding Carry?

The image below, which you can click on for greater detail, shows that Tu Yi Holding had debt of CN¥56.1m at the end of December 2023, a reduction from CN¥59.1m over a year. However, it also had CN¥43.8m in cash, and so its net debt is CN¥12.3m.

How Strong Is Tu Yi Holding's Balance Sheet?

The latest balance sheet data shows that Tu Yi Holding had liabilities of CN¥51.5m due within a year, and liabilities of CN¥37.2m falling due after that. Offsetting this, it had CN¥43.8m in cash and CN¥19.0m in receivables that were due within 12 months. So it has liabilities totalling CN¥25.9m more than its cash and near-term receivables, combined.

Given Tu Yi Holding has a market capitalization of CN¥129.9m, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Tu Yi Holding has a low debt to EBITDA ratio of only 0.86. And remarkably, despite having net debt, it actually received more in interest over the last twelve months than it had to pay. So it's fair to say it can handle debt like a hotshot teppanyaki chef handles cooking. Although Tu Yi Holding made a loss at the EBIT level, last year, it was also good to see that it generated CN¥10m in EBIT over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, Tu Yi Holding actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

Tu Yi Holding's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And the good news does not stop there, as its conversion of EBIT to free cash flow also supports that impression! Zooming out, Tu Yi Holding seems to use debt quite reasonably; and that gets the nod from us. After all, sensible leverage can boost returns on equity. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Tu Yi Holding 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. 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.