Tong Ren Tang Technologies (HKG:1666) Could Easily Take On More Debt

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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. We can see that Tong Ren Tang Technologies Co. Ltd. (HKG:1666) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Tong Ren Tang Technologies

What Is Tong Ren Tang Technologies's Net Debt?

The chart below, which you can click on for greater detail, shows that Tong Ren Tang Technologies had CN¥1.46b in debt in June 2023; about the same as the year before. But on the other hand it also has CN¥4.95b in cash, leading to a CN¥3.48b net cash position.

A Look At Tong Ren Tang Technologies' Liabilities

We can see from the most recent balance sheet that Tong Ren Tang Technologies had liabilities of CN¥2.15b falling due within a year, and liabilities of CN¥1.63b due beyond that. Offsetting this, it had CN¥4.95b in cash and CN¥1.40b in receivables that were due within 12 months. So it can boast CN¥2.58b more liquid assets than total liabilities.

This luscious liquidity implies that Tong Ren Tang Technologies' balance sheet is sturdy like a giant sequoia tree. Having regard to this fact, we think its balance sheet is as strong as an ox. 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.

Another good sign is that Tong Ren Tang Technologies has been able to increase its EBIT by 23% in twelve months, making it easier to pay down debt. 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're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 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. During the last three years, Tong Ren Tang Technologies produced sturdy free cash flow equating to 58% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While it is always sensible to investigate a company's debt, in this case Tong Ren Tang Technologies has CN¥3.48b in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 23% over the last year. So is Tong Ren Tang Technologies's debt a risk? It doesn't seem so to us. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Tong Ren Tang Technologies's earnings per share history for free.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.