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.’ It’s only natural to consider a company’s balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Tongguan Gold Group Limited (HKG:340) makes use of debt. But should shareholders be worried about its use of debt?
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. Ultimately, if the company can’t fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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.
How Much Debt Does Tongguan Gold Group Carry?
As you can see below, at the end of June 2020, Tongguan Gold Group had HK$209.9m of debt, up from HK$128.3m a year ago. Click the image for more detail. However, because it has a cash reserve of HK$162.7m, its net debt is less, at about HK$47.2m.
How Strong Is Tongguan Gold Group’s Balance Sheet?
The latest balance sheet data shows that Tongguan Gold Group had liabilities of HK$666.4m due within a year, and liabilities of HK$932.4m falling due after that. Offsetting these obligations, it had cash of HK$162.7m as well as receivables valued at HK$11.8m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$1.42b.
When you consider that this deficiency exceeds the company’s HK$1.12b market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. There’s no doubt that we learn most about debt from the balance sheet. But you can’t view debt in total isolation; since Tongguan Gold Group 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.
In the last year Tongguan Gold Group wasn’t profitable at an EBIT level, but managed to grow its revenue by 69%, to HK$178m. With any luck the company will be able to grow its way to profitability.
Despite the top line growth, Tongguan Gold Group still had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost HK$34m at the EBIT level. When we look at that alongside the significant liabilities, we’re not particularly confident about the company. We’d want to see some strong near-term improvements before getting too interested in the stock. Not least because it had negative free cash flow of HK$57m over the last twelve months. That means it’s on the risky side of things. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet – far from it. Consider risks, for instance. Every company has them, and we’ve spotted 1 warning sign for Tongguan Gold Group you should know about.
Of course, if you’re the type of investor who prefers buying stocks without the burden of debt, then don’t hesitate to discover our exclusive list of net cash growth stocks, today.
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