Stock Analysis

Is Tong Ren Tang Technologies (HKG:1666) Using Too Much Debt?

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The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. 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 A Problem?

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. If things get really bad, the lenders can take control of the business. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

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What Is Tong Ren Tang Technologies's Debt?

You can click the graphic below for the historical numbers, but it shows that Tong Ren Tang Technologies had CN¥1.50b of debt in June 2022, down from CN¥2.34b, one year before. However, its balance sheet shows it holds CN¥4.31b in cash, so it actually has CN¥2.82b net cash.

SEHK:1666 Debt to Equity History December 1st 2022

How Healthy Is Tong Ren Tang Technologies' Balance Sheet?

According to the last reported balance sheet, Tong Ren Tang Technologies had liabilities of CN¥2.78b due within 12 months, and liabilities of CN¥1.16b due beyond 12 months. Offsetting this, it had CN¥4.31b in cash and CN¥1.53b in receivables that were due within 12 months. So it actually has CN¥1.90b more liquid assets than total liabilities.

This excess liquidity is a great indication that Tong Ren Tang Technologies' balance sheet is almost as strong as Fort Knox. With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Simply put, the fact that Tong Ren Tang Technologies has more cash than debt is arguably a good indication that it can manage its debt safely.

While Tong Ren Tang Technologies doesn't seem to have gained much on the EBIT line, at least earnings remain stable for now. The balance sheet is clearly the area to focus on when you are analysing debt. 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 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. Tong Ren Tang Technologies 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. Looking at the most recent three years, Tong Ren Tang Technologies recorded free cash flow of 50% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case Tong Ren Tang Technologies has CN¥2.82b in net cash and a decent-looking balance sheet. So is Tong Ren Tang Technologies's debt a risk? It doesn't seem so to us. Another positive for shareholders is that it pays dividends. So if you like receiving those dividend payments, check Tong Ren Tang Technologies's dividend history, without delay!

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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