Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Tong Ren Tang Technologies Co. Ltd. (HKG:1666) does have debt on its balance sheet. 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. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.
What Is Tong Ren Tang Technologies's Debt?
You can click the graphic below for the historical numbers, but it shows that as of June 2021 Tong Ren Tang Technologies had CN¥2.34b of debt, an increase on CN¥1.55b, over one year. However, its balance sheet shows it holds CN¥4.64b in cash, so it actually has CN¥2.30b net cash.
How Healthy Is Tong Ren Tang Technologies' Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Tong Ren Tang Technologies had liabilities of CN¥3.32b due within 12 months and liabilities of CN¥994.5m due beyond that. On the other hand, it had cash of CN¥4.64b and CN¥1.34b worth of receivables due within a year. So it can boast CN¥1.66b more liquid assets than total liabilities.
It's good to see that Tong Ren Tang Technologies has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. 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.
On top of that, Tong Ren Tang Technologies grew its EBIT by 47% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Tong Ren Tang Technologies's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. 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. Looking at the most recent three years, Tong Ren Tang Technologies recorded free cash flow of 42% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.
While we empathize with investors who find debt concerning, you should keep in mind that Tong Ren Tang Technologies has net cash of CN¥2.30b, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 47% over the last year. So we don't think Tong Ren Tang Technologies's use of debt is risky. Given Tong Ren Tang Technologies has a strong balance sheet is profitable and pays a dividend, it would be good to know how fast its dividends are growing, if at all. You can find out instantly by clicking this link.
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.
When trading stocks or any other investment, use the platform considered by many to be the Professional's Gateway to the Worlds Market, Interactive Brokers. You get the lowest-cost* trading on stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted
Valuation is complex, but we're helping make it simple.
Find out whether Tong Ren Tang Technologies is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.View the Free Analysis
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.
*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.