Is Tongcheng Travel Holdings (HKG:780) Using Too Much Debt?

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. As with many other companies Tongcheng Travel Holdings Limited (HKG:780) makes use of debt. But is this debt a concern to shareholders?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

See 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 at September 2022 Tongcheng Travel Holdings had debt of CN¥2.23b, up from CN¥113.2m in one year. But on the other hand it also has CN¥5.44b in cash, leading to a CN¥3.21b net cash position.

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¥5.15b falling due within a year, and liabilities of CN¥3.70b due beyond that. Offsetting these obligations, it had cash of CN¥5.44b as well as receivables valued at CN¥1.34b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥2.06b.

Given Tongcheng Travel Holdings has a market capitalization of CN¥35.4b, 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. 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.

It is just as well that Tongcheng Travel Holdings's load is not too heavy, because its EBIT was down 87% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Tongcheng Travel Holdings may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the most recent three years, Tongcheng Travel Holdings recorded free cash flow worth 51% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Tongcheng Travel Holdings has CN¥3.21b in net cash. So we are not troubled with Tongcheng Travel Holdings's debt use. Even though Tongcheng Travel Holdings lost money on the bottom line, its positive EBIT suggests the business itself has potential. So you might want to check out how earnings have been trending over the last few years.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.