These 4 Measures Indicate That Tiande Chemical Holdings (HKG:609) Is Using Debt Safely

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. We note that Tiande Chemical Holdings Limited (HKG:609) does have debt on its balance sheet. But is this debt a concern to shareholders?

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. 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. 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.

See our latest analysis for Tiande Chemical Holdings

What Is Tiande Chemical Holdings's Debt?

You can click the graphic below for the historical numbers, but it shows that Tiande Chemical Holdings had CN¥90.7m of debt in June 2022, down from CN¥183.3m, one year before. However, it does have CN¥360.9m in cash offsetting this, leading to net cash of CN¥270.2m.

A Look At Tiande Chemical Holdings' Liabilities

We can see from the most recent balance sheet that Tiande Chemical Holdings had liabilities of CN¥603.0m falling due within a year, and liabilities of CN¥28.2m due beyond that. On the other hand, it had cash of CN¥360.9m and CN¥935.0m worth of receivables due within a year. So it can boast CN¥664.8m more liquid assets than total liabilities.

This luscious liquidity implies that Tiande Chemical Holdings' balance sheet is sturdy like a giant sequoia tree. Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that Tiande Chemical Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.

Better yet, Tiande Chemical Holdings grew its EBIT by 980% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Tiande Chemical Holdings's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Tiande Chemical Holdings may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Tiande Chemical Holdings reported free cash flow worth 19% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Tiande Chemical Holdings has net cash of CN¥270.2m, as well as more liquid assets than liabilities. And we liked the look of last year's 980% year-on-year EBIT growth. So we don't think Tiande Chemical Holdings's use of debt is risky. 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. To that end, you should learn about the 3 warning signs we've spotted with Tiande Chemical Holdings (including 1 which is significant) .

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.