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.' 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 can see that Tiangong International Company Limited (HKG:826) does use debt in its business. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. When we think about a company's use of debt, we first look at cash and debt together.
Check out our latest analysis for Tiangong International
How Much Debt Does Tiangong International Carry?
You can click the graphic below for the historical numbers, but it shows that Tiangong International had CN¥2.77b of debt in June 2021, down from CN¥3.24b, one year before. However, its balance sheet shows it holds CN¥3.63b in cash, so it actually has CN¥861.9m net cash.
A Look At Tiangong International's Liabilities
We can see from the most recent balance sheet that Tiangong International had liabilities of CN¥5.13b falling due within a year, and liabilities of CN¥970.2m due beyond that. Offsetting this, it had CN¥3.63b in cash and CN¥2.02b in receivables that were due within 12 months. So it has liabilities totalling CN¥444.8m more than its cash and near-term receivables, combined.
Since publicly traded Tiangong International shares are worth a total of CN¥11.9b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Tiangong International boasts net cash, so it's fair to say it does not have a heavy debt load!
Also positive, Tiangong International grew its EBIT by 20% in the last year, and that should make it easier to pay down debt, going forward. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Tiangong International'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.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Tiangong International 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. During the last three years, Tiangong International produced sturdy free cash flow equating to 72% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
Summing up
While it is always sensible to look at a company's total liabilities, it is very reassuring that Tiangong International has CN¥861.9m in net cash. And it impressed us with free cash flow of CN¥831m, being 72% of its EBIT. So we don't think Tiangong International's use of debt is risky. 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. For instance, we've identified 3 warning signs for Tiangong International that you should be aware of.
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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About SEHK:826
Tiangong International
Manufactures and sells alloy steel, cutting tools, titanium alloys, and related products in the People’s Republic of China, North America, Europe, other Asian countries, and internationally.
Excellent balance sheet and slightly overvalued.