Tongcheng Travel Holdings (HKG:780) Has A Pretty Healthy Balance Sheet

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, plenty of companies use debt to fund growth, without any negative consequences. 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 Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2023 Tongcheng Travel Holdings had CN¥1.97b of debt, an increase on CN¥329.4m, over one year. However, its balance sheet shows it holds CN¥6.79b in cash, so it actually has CN¥4.82b net cash.

How Healthy Is Tongcheng Travel Holdings' Balance Sheet?

According to the last reported balance sheet, Tongcheng Travel Holdings had liabilities of CN¥7.99b due within 12 months, and liabilities of CN¥2.53b due beyond 12 months. Offsetting these obligations, it had cash of CN¥6.79b as well as receivables valued at CN¥1.27b due within 12 months. So it has liabilities totalling CN¥2.46b more than its cash and near-term receivables, combined.

Of course, Tongcheng Travel Holdings has a market capitalization of CN¥38.8b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Tongcheng Travel Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Tongcheng Travel Holdings if management cannot prevent a repeat of the 59% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Tongcheng Travel Holdings can strengthen its balance sheet over time. 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. 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

While it is always sensible to look at a company's total liabilities, it is very reassuring that Tongcheng Travel Holdings has CN¥4.82b in net cash. And it impressed us with free cash flow of CN¥1.1b, being 269% of its EBIT. So we are not troubled with Tongcheng Travel Holdings's debt use. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 2 warning signs for Tongcheng Travel Holdings that you should be aware of.

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.