Is Tianli International Holdings (HKG:1773) Using Too Much Debt?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. Importantly, Tianli International Holdings Limited (HKG:1773) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. If things get really bad, the lenders can take control of the business. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Tianli International Holdings

How Much Debt Does Tianli International Holdings Carry?

As you can see below, at the end of August 2023, Tianli International Holdings had CN¥1.67b of debt, up from CN¥1.13b a year ago. Click the image for more detail. However, it also had CN¥1.60b in cash, and so its net debt is CN¥70.4m.

How Healthy Is Tianli International Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Tianli International Holdings had liabilities of CN¥4.57b due within 12 months and liabilities of CN¥2.89b due beyond that. Offsetting these obligations, it had cash of CN¥1.60b as well as receivables valued at CN¥689.2m due within 12 months. So it has liabilities totalling CN¥5.17b more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of CN¥5.52b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. Carrying virtually no net debt, Tianli International Holdings has a very light debt load indeed.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Tianli International Holdings has net debt of just 0.12 times EBITDA, indicating that it is certainly not a reckless borrower. And this view is supported by the solid interest coverage, with EBIT coming in at 8.2 times the interest expense over the last year. Better yet, Tianli International Holdings grew its EBIT by 227% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Tianli International Holdings's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last two years, Tianli International Holdings recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Our View

While Tianli International Holdings's conversion of EBIT to free cash flow has us nervous. To wit both its EBIT growth rate and net debt to EBITDA were encouraging signs. We think that Tianli International Holdings's debt does make it a bit risky, after considering the aforementioned data points together. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. 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 1 warning sign for Tianli International Holdings that you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.