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

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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Tongcheng Travel Holdings Limited (HKG:780) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at 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 at March 2022 Tongcheng Travel Holdings had debt of CN¥2.01b, up from CN¥133.0m in one year. But on the other hand it also has CN¥6.50b in cash, leading to a CN¥4.49b net cash position.

A Look At Tongcheng Travel Holdings' Liabilities

We can see from the most recent balance sheet that Tongcheng Travel Holdings had liabilities of CN¥4.12b falling due within a year, and liabilities of CN¥3.33b due beyond that. On the other hand, it had cash of CN¥6.50b and CN¥696.7m worth of receivables due within a year. So it has liabilities totalling CN¥247.5m more than its cash and near-term receivables, combined.

Having regard to Tongcheng Travel Holdings' size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the CN¥27.1b company is short on cash, but still worth keeping an eye on the balance sheet. 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.

In addition to that, we're happy to report that Tongcheng Travel Holdings has boosted its EBIT by 37%, thus reducing the spectre of future debt repayments. 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. Over the last three years, Tongcheng Travel Holdings actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

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¥4.49b. And it impressed us with free cash flow of CN¥476m, being 120% of its EBIT. So we don't think Tongcheng Travel Holdings's use of debt is risky. 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. Be aware that Tongcheng Travel Holdings is showing 1 warning sign in our investment analysis , you should know about...

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.