Would Tu Yi Holding (HKG:1701) Be Better Off With Less Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Tu Yi Holding Company Limited (HKG:1701) does have debt on its balance sheet. 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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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 examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Tu Yi Holding

What Is Tu Yi Holding's Net Debt?

As you can see below, at the end of June 2021, Tu Yi Holding had CN¥62.8m of debt, up from CN¥59.7m a year ago. Click the image for more detail. However, it does have CN¥38.9m in cash offsetting this, leading to net debt of about CN¥23.9m.

How Strong Is Tu Yi Holding's Balance Sheet?

We can see from the most recent balance sheet that Tu Yi Holding had liabilities of CN¥38.5m falling due within a year, and liabilities of CN¥45.5m due beyond that. Offsetting these obligations, it had cash of CN¥38.9m as well as receivables valued at CN¥171.0k due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥45.0m.

This deficit isn't so bad because Tu Yi Holding is worth CN¥123.4m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. When analysing debt levels, the balance sheet is the obvious place to start. 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

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. Indeed, it lost a very considerable CN¥35m 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. So we think its balance sheet is a little strained, though not beyond repair. 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. For instance, we've identified 4 warning signs for Tu Yi Holding (1 doesn't sit too well with us) you should be aware of.

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.