Health Check: How Prudently Does Tree Holdings (HKG:8395) Use 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.' 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 Tree Holdings Limited (HKG:8395) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Tree Holdings

What Is Tree Holdings's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2022 Tree Holdings had HK$18.6m of debt, an increase on HK$6.49m, over one year. However, its balance sheet shows it holds HK$23.3m in cash, so it actually has HK$4.66m net cash.

How Healthy Is Tree Holdings' Balance Sheet?

According to the last reported balance sheet, Tree Holdings had liabilities of HK$38.4m due within 12 months, and liabilities of HK$5.47m due beyond 12 months. Offsetting this, it had HK$23.3m in cash and HK$31.1m in receivables that were due within 12 months. So it can boast HK$10.5m more liquid assets than total liabilities.

Having regard to Tree Holdings' size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the HK$1.47b company is short on cash, but still worth keeping an eye on the balance sheet. Simply put, the fact that Tree Holdings has more cash than debt is arguably a good indication that it can manage its debt safely. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Tree 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.

In the last year Tree Holdings had a loss before interest and tax, and actually shrunk its revenue by 29%, to HK$86m. To be frank that doesn't bode well.

So How Risky Is Tree Holdings?

Although Tree Holdings had an earnings before interest and tax (EBIT) loss over the last twelve months, it made a statutory profit of HK$977k. So taking that on face value, and considering the cash, we don't think its very risky in the near term. With mediocre revenue growth in the last year, we're don't find the investment opportunity particularly compelling. 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. To that end, you should be aware of the 2 warning signs we've spotted with Tree Holdings .

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.