Tencent Holdings (HKG:700) Has A Rock Solid Balance Sheet

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 Tencent Holdings Limited (HKG:700) makes use of debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Tencent Holdings

What Is Tencent Holdings's Debt?

The chart below, which you can click on for greater detail, shows that Tencent Holdings had CN¥351.0b in debt in September 2023; about the same as the year before. However, its balance sheet shows it holds CN¥362.5b in cash, so it actually has CN¥11.5b net cash.

A Look At Tencent Holdings' Liabilities

Zooming in on the latest balance sheet data, we can see that Tencent Holdings had liabilities of CN¥362.3b due within 12 months and liabilities of CN¥347.9b due beyond that. Offsetting these obligations, it had cash of CN¥362.5b as well as receivables valued at CN¥47.3b due within 12 months. So its liabilities total CN¥300.5b more than the combination of its cash and short-term receivables.

Since publicly traded Tencent Holdings shares are worth a very impressive total of CN¥2.44t, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Tencent Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

Another good sign is that Tencent Holdings has been able to increase its EBIT by 28% in twelve months, making it easier to pay down debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Tencent Holdings can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Tencent 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, Tencent Holdings 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 Tencent Holdings does have more liabilities than liquid assets, it also has net cash of CN¥11.5b. The cherry on top was that in converted 101% of that EBIT to free cash flow, bringing in CN¥149b. So is Tencent Holdings's debt a risk? It doesn't seem so to us. 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. We've identified 1 warning sign with Tencent Holdings , and understanding them should be part of your investment process.

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.

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

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.