We Think Tong Ren Tang Technologies (HKG:1666) Can Manage Its Debt With Ease

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 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 can see that Tong Ren Tang Technologies Co. Ltd. (HKG:1666) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Tong Ren Tang Technologies

What Is Tong Ren Tang Technologies's Debt?

The image below, which you can click on for greater detail, shows that at June 2021 Tong Ren Tang Technologies had debt of CN¥2.34b, up from CN¥1.55b in one year. However, it does have CN¥4.64b in cash offsetting this, leading to net cash of CN¥2.30b.

How Healthy Is Tong Ren Tang Technologies' Balance Sheet?

We can see from the most recent balance sheet that Tong Ren Tang Technologies had liabilities of CN¥3.32b falling due within a year, and liabilities of CN¥994.5m due beyond that. Offsetting these obligations, it had cash of CN¥4.64b as well as receivables valued at CN¥1.34b due within 12 months. So it actually has CN¥1.66b more liquid assets than total liabilities.

This excess liquidity suggests that Tong Ren Tang Technologies is taking a careful approach to debt. 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.

In addition to that, we're happy to report that Tong Ren Tang Technologies has boosted its EBIT by 47%, thus reducing the spectre of future debt repayments. 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, 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 42% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing up

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 we liked the look of last year's 47% year-on-year EBIT growth. So is Tong Ren Tang Technologies's debt a risk? It doesn't seem so to us. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.