Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Tong Ren Tang Technologies Co. Ltd. (HKG:1666) does carry debt. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Tong Ren Tang Technologies's Debt?
You can click the graphic below for the historical numbers, but it shows that as of December 2020 Tong Ren Tang Technologies had CN¥1.54b of debt, an increase on CN¥1.36b, over one year. But on the other hand it also has CN¥3.49b in cash, leading to a CN¥1.95b net cash position.
How Strong Is Tong Ren Tang Technologies' Balance Sheet?
The latest balance sheet data shows that Tong Ren Tang Technologies had liabilities of CN¥2.45b due within a year, and liabilities of CN¥734.4m falling due after that. Offsetting these obligations, it had cash of CN¥3.49b as well as receivables valued at CN¥1.04b due within 12 months. So it can boast CN¥1.34b more liquid assets than total liabilities.
This surplus suggests that Tong Ren Tang Technologies is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Succinctly put, Tong Ren Tang Technologies boasts net cash, so it's fair to say it does not have a heavy debt load!
Fortunately, Tong Ren Tang Technologies grew its EBIT by 3.1% in the last year, making that debt load look even more manageable. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Tong Ren Tang Technologies can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Tong Ren Tang Technologies 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. In the last three years, Tong Ren Tang Technologies's free cash flow amounted to 45% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.
While it is always sensible to investigate a company's debt, in this case Tong Ren Tang Technologies has CN¥1.95b in net cash and a decent-looking balance sheet. On top of that, it increased its EBIT by 3.1% in the last twelve months. So we don't think Tong Ren Tang Technologies'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. We've identified 2 warning signs with Tong Ren Tang Technologies , 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.
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