Tiangong International (HKG:826) Has A Pretty Healthy Balance Sheet

Warren Buffett famously said, '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 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?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Tiangong International

What Is Tiangong International's Net Debt?

The chart below, which you can click on for greater detail, shows that Tiangong International had CN¥3.37b in debt in December 2020; about the same as the year before. However, it also had CN¥2.05b in cash, and so its net debt is CN¥1.31b.

How Strong Is Tiangong International's Balance Sheet?

We can see from the most recent balance sheet that Tiangong International had liabilities of CN¥4.81b falling due within a year, and liabilities of CN¥751.0m due beyond that. Offsetting these obligations, it had cash of CN¥2.05b as well as receivables valued at CN¥2.14b due within 12 months. So its liabilities total CN¥1.36b more than the combination of its cash and short-term receivables.

Since publicly traded Tiangong International shares are worth a total of CN¥9.09b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

While Tiangong International's low debt to EBITDA ratio of 1.3 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 6.0 times last year does give us pause. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. Also relevant is that Tiangong International has grown its EBIT by a very respectable 28% in the last year, thus enhancing its ability to pay down debt. When analysing debt levels, the balance sheet is the obvious place to start. 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. So we always check how much of that EBIT is translated into free cash flow. In the last three years, Tiangong International's free cash flow amounted to 23% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

Happily, Tiangong International's impressive EBIT growth rate implies it has the upper hand on its debt. But, on a more sombre note, we are a little concerned by its conversion of EBIT to free cash flow. All these things considered, it appears that Tiangong International can comfortably handle its current debt levels. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 3 warning signs for Tiangong International you should be aware of, and 1 of them is concerning.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

If you’re looking to trade Tiangong International, open an account with the lowest-cost* platform trusted by professionals, Interactive Brokers. Their clients from over 200 countries and territories trade stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted

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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.