Here's Why Tian Chang Group Holdings (HKG:2182) Has A Meaningful Debt Burden

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Tian Chang Group Holdings Ltd. (HKG:2182) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Tian Chang Group Holdings

How Much Debt Does Tian Chang Group Holdings Carry?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 Tian Chang Group Holdings had HK$256.6m of debt, an increase on HK$151.1m, over one year. However, because it has a cash reserve of HK$117.1m, its net debt is less, at about HK$139.5m.

How Strong Is Tian Chang Group Holdings' Balance Sheet?

According to the last reported balance sheet, Tian Chang Group Holdings had liabilities of HK$456.1m due within 12 months, and liabilities of HK$68.9m due beyond 12 months. Offsetting this, it had HK$117.1m in cash and HK$179.2m in receivables that were due within 12 months. So its liabilities total HK$228.8m more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of HK$257.3m, so it does suggest shareholders should keep an eye on Tian Chang Group Holdings' use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Tian Chang Group Holdings has a low net debt to EBITDA ratio of only 1.2. And its EBIT covers its interest expense a whopping 10.7 times over. So we're pretty relaxed about its super-conservative use of debt. In fact Tian Chang Group Holdings's saving grace is its low debt levels, because its EBIT has tanked 47% in the last twelve months. 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 it is Tian Chang Group Holdings'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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Tian Chang Group Holdings produced sturdy free cash flow equating to 53% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Mulling over Tian Chang Group Holdings's attempt at (not) growing its EBIT, we're certainly not enthusiastic. But on the bright side, its interest cover is a good sign, and makes us more optimistic. Once we consider all the factors above, together, it seems to us that Tian Chang Group Holdings's debt is making it a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. 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. These risks can be hard to spot. Every company has them, and we've spotted 4 warning signs for Tian Chang Group Holdings you should know about.

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. 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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