Stock Analysis

Is Tan Chong International (HKG:693) A Risky Investment?

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Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Tan Chong International Limited (HKG:693) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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. When we examine debt levels, we first consider both cash and debt levels, together.

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How Much Debt Does Tan Chong International Carry?

You can click the graphic below for the historical numbers, but it shows that Tan Chong International had HK$2.75b of debt in December 2020, down from HK$3.22b, one year before. But on the other hand it also has HK$4.31b in cash, leading to a HK$1.57b net cash position.

SEHK:693 Debt to Equity History April 5th 2021

How Healthy Is Tan Chong International's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Tan Chong International had liabilities of HK$4.13b due within 12 months and liabilities of HK$1.62b due beyond that. Offsetting these obligations, it had cash of HK$4.31b as well as receivables valued at HK$1.64b due within 12 months. So it actually has HK$195.7m more liquid assets than total liabilities.

This surplus suggests that Tan Chong International has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Tan Chong International has more cash than debt is arguably a good indication that it can manage its debt safely.

Importantly Tan Chong International's EBIT was essentially flat over the last twelve months. Ideally it can diminish its debt load by kick-starting earnings growth. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Tan Chong International will need earnings to service that debt. 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Tan Chong International 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. Considering the last three years, Tan Chong International actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Summing up

While it is always sensible to investigate a company's debt, in this case Tan Chong International has HK$1.57b in net cash and a decent-looking balance sheet. So we don't have any problem with Tan Chong International's use of debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 3 warning signs for Tan Chong International you should be aware of, and 1 of them makes us a bit uncomfortable.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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This article by Simply Wall St is general in nature. 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.
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