These 4 Measures Indicate That Tongcheng Travel Holdings (HKG:780) Is Using Debt Safely

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.' 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 the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Tongcheng Travel Holdings

What Is Tongcheng Travel Holdings's Net Debt?

The image below, which you can click on for greater detail, shows that Tongcheng Travel Holdings had debt of CN¥118.2m at the end of September 2021, a reduction from CN¥163.5m over a year. But on the other hand it also has CN¥6.25b in cash, leading to a CN¥6.13b net cash position.

A Look At Tongcheng Travel Holdings' Liabilities

The latest balance sheet data shows that Tongcheng Travel Holdings had liabilities of CN¥4.62b due within a year, and liabilities of CN¥2.13b falling due after that. Offsetting this, it had CN¥6.25b in cash and CN¥962.9m in receivables that were due within 12 months. So it actually has CN¥472.8m more liquid assets than total liabilities.

This state of affairs indicates that Tongcheng Travel Holdings' balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the CN¥26.1b company is short on cash, but still worth keeping an eye on the balance sheet. Succinctly put, Tongcheng Travel Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Tongcheng Travel Holdings grew its EBIT by 49% over the last twelve months, and that growth will make it easier to handle its debt. 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 want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 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. 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 conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Tongcheng Travel Holdings has net cash of CN¥6.13b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥1.6b, being 131% of its EBIT. So is Tongcheng Travel Holdings's debt a risk? It doesn't seem so to us. Another factor that would give us confidence in Tongcheng Travel Holdings would be if insiders have been buying shares: if you're conscious of that signal too, you can find out instantly by clicking this link.

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.