Is Tongdao Liepin Group (HKG:6100) Using Too Much Debt?

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. Importantly, Tongdao Liepin Group (HKG:6100) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Tongdao Liepin Group

What Is Tongdao Liepin Group's Net Debt?

As you can see below, at the end of September 2020, Tongdao Liepin Group had CN¥72.5m of debt, up from CN¥59.0m a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥2.33b in cash, so it actually has CN¥2.25b net cash.

How Healthy Is Tongdao Liepin Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Tongdao Liepin Group had liabilities of CN¥1.12b due within 12 months and liabilities of CN¥96.1m due beyond that. Offsetting these obligations, it had cash of CN¥2.33b as well as receivables valued at CN¥90.0m due within 12 months. So it actually has CN¥1.21b more liquid assets than total liabilities.

This surplus suggests that Tongdao Liepin Group has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Tongdao Liepin Group boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact Tongdao Liepin Group's saving grace is its low debt levels, because its EBIT has tanked 21% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. 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 Tongdao Liepin Group's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Tongdao Liepin Group has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last two years, Tongdao Liepin Group actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Tongdao Liepin Group has net cash of CN¥2.25b, as well as more liquid assets than liabilities. The cherry on top was that in converted 261% of that EBIT to free cash flow, bringing in CN¥208m. So we don't have any problem with Tongdao Liepin Group's use of debt. Over time, share prices tend to follow earnings per share, so if you're interested in Tongdao Liepin Group, you may well want to click here to check an interactive graph of its earnings per share history.

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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