Is Tongcheng Travel Holdings (HKG:780) A Risky Investment?

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. We can see that Tongcheng Travel Holdings Limited (HKG:780) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Tongcheng Travel Holdings

What Is Tongcheng Travel Holdings's Debt?

The image below, which you can click on for greater detail, shows that Tongcheng Travel Holdings had debt of CN¥1.95b at the end of September 2023, a reduction from CN¥2.23b over a year. However, it does have CN¥8.20b in cash offsetting this, leading to net cash of CN¥6.25b.

How Healthy Is Tongcheng Travel Holdings' Balance Sheet?

We can see from the most recent balance sheet that Tongcheng Travel Holdings had liabilities of CN¥9.90b falling due within a year, and liabilities of CN¥2.39b due beyond that. On the other hand, it had cash of CN¥8.20b and CN¥1.45b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥2.64b.

Given Tongcheng Travel Holdings has a market capitalization of CN¥40.7b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Tongcheng Travel Holdings also has more cash than debt, so we're pretty confident it can manage its debt safely.

Even more impressive was the fact that Tongcheng Travel Holdings grew its EBIT by 1,693% over twelve months. 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 Tongcheng Travel 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Tongcheng Travel Holdings has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, Tongcheng Travel Holdings actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

We could understand if investors are concerned about Tongcheng Travel Holdings's liabilities, but we can be reassured by the fact it has has net cash of CN¥6.25b. The cherry on top was that in converted 236% of that EBIT to free cash flow, bringing in CN¥3.7b. So we don't think Tongcheng Travel Holdings's use of debt is risky. Over time, share prices tend to follow earnings per share, so if you're interested in Tongcheng Travel Holdings, you may well want to click here to check an interactive graph of its earnings per share history.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.