Here's Why Touyun Biotech Group (HKG:1332) Can Afford Some Debt

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. We note that Touyun Biotech Group Limited (HKG:1332) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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.

Check out our latest analysis for Touyun Biotech Group

What Is Touyun Biotech Group's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2022 Touyun Biotech Group had debt of HK$428.1m, up from HK$375.1m in one year. However, it does have HK$60.9m in cash offsetting this, leading to net debt of about HK$367.2m.

How Healthy Is Touyun Biotech Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Touyun Biotech Group had liabilities of HK$577.6m due within 12 months and liabilities of HK$10.7m due beyond that. Offsetting these obligations, it had cash of HK$60.9m as well as receivables valued at HK$154.7m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$372.6m.

While this might seem like a lot, it is not so bad since Touyun Biotech Group has a market capitalization of HK$1.63b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. There's no doubt that we learn most about debt from the balance sheet. But it is Touyun Biotech Group's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, Touyun Biotech Group reported revenue of HK$313m, which is a gain of 24%, although it did not report any earnings before interest and tax. Shareholders probably have their fingers crossed that it can grow its way to profits.

Caveat Emptor

While we can certainly appreciate Touyun Biotech Group's revenue growth, its earnings before interest and tax (EBIT) loss is not ideal. To be specific the EBIT loss came in at HK$37m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled HK$217m in negative free cash flow over the last twelve months. So suffice it to say we consider the stock very risky. 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 example - Touyun Biotech Group has 1 warning sign we think you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.