We Think Tern Properties (HKG:277) Can Stay On Top Of Its Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Tern Properties Company Limited (HKG:277) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Tern Properties

What Is Tern Properties's Net Debt?

As you can see below, Tern Properties had HK$47.3m of debt at March 2023, down from HK$50.2m a year prior. But on the other hand it also has HK$172.8m in cash, leading to a HK$125.5m net cash position.

How Healthy Is Tern Properties' Balance Sheet?

According to the last reported balance sheet, Tern Properties had liabilities of HK$20.5m due within 12 months, and liabilities of HK$88.8m due beyond 12 months. On the other hand, it had cash of HK$172.8m and HK$8.39m worth of receivables due within a year. So it actually has HK$71.9m more liquid assets than total liabilities.

This surplus suggests that Tern Properties has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Tern Properties boasts net cash, so it's fair to say it does not have a heavy debt load!

On the other hand, Tern Properties's EBIT dived 14%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. When analysing debt levels, the balance sheet is the obvious place to start. But it is Tern Properties's earnings that will influence how the balance sheet holds up in the future. 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. While Tern Properties 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. Over the last three years, Tern Properties actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While it is always sensible to investigate a company's debt, in this case Tern Properties has HK$125.5m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of HK$13m, being 156% of its EBIT. So we don't think Tern Properties's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Tern Properties is showing 1 warning sign in our investment analysis , you should know about...

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.