Tibet Water Resources (HKG:1115) Seems To Use Debt Quite Sensibly

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 Tibet Water Resources Ltd. (HKG:1115) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Tibet Water Resources

How Much Debt Does Tibet Water Resources Carry?

You can click the graphic below for the historical numbers, but it shows that Tibet Water Resources had CN¥804.9m of debt in June 2021, down from CN¥1.05b, one year before. However, its balance sheet shows it holds CN¥1.18b in cash, so it actually has CN¥375.4m net cash.

A Look At Tibet Water Resources' Liabilities

We can see from the most recent balance sheet that Tibet Water Resources had liabilities of CN¥883.2m falling due within a year, and liabilities of CN¥475.4m due beyond that. Offsetting this, it had CN¥1.18b in cash and CN¥208.2m in receivables that were due within 12 months. So it actually has CN¥29.9m more liquid assets than total liabilities.

This surplus suggests that Tibet Water Resources has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Tibet Water Resources has more cash than debt is arguably a good indication that it can manage its debt safely.

Shareholders should be aware that Tibet Water Resources's EBIT was down 40% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Tibet Water Resources will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Tibet Water Resources 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. Over the last three years, Tibet Water Resources actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Tibet Water Resources has net cash of CN¥375.4m, as well as more liquid assets than liabilities. The cherry on top was that in converted 157% of that EBIT to free cash flow, bringing in CN¥81m. So we don't have any problem with Tibet Water Resources's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 3 warning signs for Tibet Water Resources (1 is a bit concerning!) that you should be aware of before investing here.

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.
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