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.' 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 real question is whether this debt is making the company risky.
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. 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 Net Debt?
The chart below, which you can click on for greater detail, shows that Tong Ren Tang Technologies had CN¥1.49b in debt in December 2021; about the same as the year before. But it also has CN¥3.89b in cash to offset that, meaning it has CN¥2.39b net cash.
A Look At Tong Ren Tang Technologies' Liabilities
The latest balance sheet data shows that Tong Ren Tang Technologies had liabilities of CN¥2.46b due within a year, and liabilities of CN¥977.3m falling due after that. Offsetting these obligations, it had cash of CN¥3.89b as well as receivables valued at CN¥1.19b due within 12 months. So it can boast CN¥1.65b 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. Succinctly put, Tong Ren Tang Technologies boasts net cash, so it's fair to say it does not have a heavy debt load!
And we also note warmly that Tong Ren Tang Technologies grew its EBIT by 14% last year, making its debt load easier to handle. The balance sheet is clearly the area to focus on when you are analysing debt. 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, 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 weak cash conversion makes it more difficult to handle indebtedness.
While we empathize with investors who find debt concerning, you should keep in mind that Tong Ren Tang Technologies has net cash of CN¥2.39b, as well as more liquid assets than liabilities. And it also grew its EBIT by 14% over the last year. So we don't think Tong Ren Tang Technologies's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example - Tong Ren Tang Technologies has 1 warning sign we think you should be aware of.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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.