We Think Tu Yi Holding (HKG:1701) Has A Fair Chunk Of Debt

Warren Buffett famously said, '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 note that Tu Yi Holding Company Limited (HKG:1701) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. 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?

You can click the graphic below for the historical numbers, but it shows that as of June 2021 Tu Yi Holding had CN¥62.8m of debt, an increase on CN¥59.7m, over one year. However, because it has a cash reserve of CN¥38.9m, its net debt is less, at about CN¥23.9m.

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¥38.5m due within 12 months and liabilities of CN¥45.5m due beyond that. On the other hand, it had cash of CN¥38.9m and CN¥171.0k worth of receivables due within a year. So its liabilities total CN¥45.0m more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Tu Yi Holding is worth CN¥174.4m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. 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 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¥19m. That makes us nervous, to say the least.

Caveat Emptor

Not only did Tu Yi Holding's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost a very considerable CN¥35m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled CN¥11m in negative free cash flow over the last twelve months. So in short it's a really risky stock. 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. Case in point: We've spotted 3 warning signs for Tu Yi Holding you should be aware of, and 1 of them is a bit unpleasant.

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.
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