Is Tongda Hong Tai Holdings (HKG:2363) Using Too Much Debt?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Tongda Hong Tai Holdings Limited (HKG:2363) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Tongda Hong Tai Holdings

How Much Debt Does Tongda Hong Tai Holdings Carry?

As you can see below, Tongda Hong Tai Holdings had HK$236.7m of debt at June 2021, down from HK$276.0m a year prior. However, because it has a cash reserve of HK$10.5m, its net debt is less, at about HK$226.1m.

A Look At Tongda Hong Tai Holdings' Liabilities

The latest balance sheet data shows that Tongda Hong Tai Holdings had liabilities of HK$413.4m due within a year, and liabilities of HK$6.83m falling due after that. Offsetting this, it had HK$10.5m in cash and HK$153.8m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$255.9m.

The deficiency here weighs heavily on the HK$45.8m 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. After all, Tongda Hong Tai Holdings would likely require a major re-capitalisation if it had to pay its creditors today. When analysing debt levels, the balance sheet is the obvious place to start. But it is Tongda Hong Tai Holdings'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.

In the last year Tongda Hong Tai Holdings had a loss before interest and tax, and actually shrunk its revenue by 3.4%, to HK$452m. That's not what we would hope to see.

Caveat Emptor

Importantly, Tongda Hong Tai Holdings had an earnings before interest and tax (EBIT) loss over the last year. Its EBIT loss was a whopping HK$116m. Combining this information with the significant liabilities we already touched on makes us very hesitant about this stock, to say the least. That said, it is possible that the company will turn its fortunes around. Nevertheless, we would not bet on it given that it lost HK$178m in just last twelve months, and it doesn't have much by way of liquid assets. So we think this stock is quite risky. We'd prefer to pass. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 4 warning signs for Tongda Hong Tai Holdings you should be aware of, and 2 of them shouldn't be ignored.

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.