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

Warren Buffett famously said, '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. Importantly, Golden Wheel Tiandi Holdings Company Limited (HKG:1232) does carry debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Golden Wheel Tiandi Holdings

What Is Golden Wheel Tiandi Holdings's Debt?

As you can see below, Golden Wheel Tiandi Holdings had CN¥4.21b of debt at June 2024, down from CN¥5.25b a year prior. However, it does have CN¥137.4m in cash offsetting this, leading to net debt of about CN¥4.07b.

How Healthy Is Golden Wheel Tiandi Holdings' Balance Sheet?

According to the last reported balance sheet, Golden Wheel Tiandi Holdings had liabilities of CN¥7.37b due within 12 months, and liabilities of CN¥1.15b due beyond 12 months. On the other hand, it had cash of CN¥137.4m and CN¥583.0m worth of receivables due within a year. So its liabilities total CN¥7.80b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the CN¥34.5m 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'd watch its balance sheet closely, without a doubt. After all, Golden Wheel Tiandi Holdings would likely require a major re-capitalisation if it had to pay its creditors today.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Weak interest cover of 1.6 times and a disturbingly high net debt to EBITDA ratio of 8.4 hit our confidence in Golden Wheel Tiandi Holdings like a one-two punch to the gut. The debt burden here is substantial. However, the silver lining was that Golden Wheel Tiandi Holdings achieved a positive EBIT of CN¥451m in the last twelve months, an improvement on the prior year's loss. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Golden Wheel Tiandi Holdings will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. During the last year, Golden Wheel Tiandi Holdings generated free cash flow amounting to a very robust 85% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Our View

On the face of it, Golden Wheel Tiandi Holdings's net debt to EBITDA left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. Looking at the bigger picture, it seems clear to us that Golden Wheel Tiandi Holdings's use of debt is creating risks for the company. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 3 warning signs for Golden Wheel Tiandi Holdings (2 don't sit too well with us!) that you should be aware of before investing here.

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.