Is Golden Wheel Tiandi Holdings (HKG:1232) A Risky Investment?

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 note that Golden Wheel Tiandi Holdings Company Limited (HKG:1232) does have debt on its balance sheet. 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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth 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.

Check out our latest analysis for Golden Wheel Tiandi Holdings

How Much Debt Does Golden Wheel Tiandi Holdings Carry?

The image below, which you can click on for greater detail, shows that Golden Wheel Tiandi Holdings had debt of CN¥4.33b at the end of December 2023, a reduction from CN¥5.16b over a year. However, it also had CN¥209.3m in cash, and so its net debt is CN¥4.12b.

A Look At Golden Wheel Tiandi Holdings' Liabilities

Zooming in on the latest balance sheet data, we can see that Golden Wheel Tiandi Holdings had liabilities of CN¥7.78b due within 12 months and liabilities of CN¥1.25b due beyond that. Offsetting this, it had CN¥209.3m in cash and CN¥275.9m in receivables that were due within 12 months. So its liabilities total CN¥8.55b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the CN¥58.2m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. At the end of the day, Golden Wheel Tiandi Holdings would probably need a major re-capitalization if its creditors were to demand repayment.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Weak interest cover of 0.74 times and a disturbingly high net debt to EBITDA ratio of 14.9 hit our confidence in Golden Wheel Tiandi Holdings like a one-two punch to the gut. The debt burden here is substantial. One redeeming factor for Golden Wheel Tiandi Holdings is that it turned last year's EBIT loss into a gain of CN¥226m, over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is Golden Wheel Tiandi Holdings's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, Golden Wheel Tiandi Holdings recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Our View

To be frank both Golden Wheel Tiandi Holdings's interest cover and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But at least its EBIT growth rate is not so bad. After considering the datapoints discussed, we think Golden Wheel Tiandi Holdings has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 3 warning signs we've spotted with Golden Wheel Tiandi Holdings .

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.