Is Tongda Hong Tai Holdings (HKG:2363) Weighed On By Its Debt Load?

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?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at 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$276.0m of debt at June 2020, down from HK$328.3m a year prior. However, it does have HK$13.1m in cash offsetting this, leading to net debt of about HK$262.9m.

A Look At Tongda Hong Tai Holdings's Liabilities

We can see from the most recent balance sheet that Tongda Hong Tai Holdings had liabilities of HK$399.8m falling due within a year, and liabilities of HK$9.47m due beyond that. Offsetting these obligations, it had cash of HK$13.1m as well as receivables valued at HK$218.9m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$177.2m.

This deficit casts a shadow over the HK$71.9m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Tongda Hong Tai Holdings would probably need a major re-capitalization if its creditors were to demand repayment. There's no doubt that we learn most about debt from the balance sheet. But it is Tongda Hong Tai Holdings's earnings that will influence how the balance sheet holds up in the future. 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.

Over 12 months, Tongda Hong Tai Holdings made a loss at the EBIT level, and saw its revenue drop to HK$468m, which is a fall of 11%. That's not what we would hope to see.

Caveat Emptor

While Tongda Hong Tai Holdings's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Its EBIT loss was a whopping HK$77m. Considering that alongside the liabilities mentioned above make us nervous about the company. It would need to improve its operations quickly for us to be interested in it. For example, we would not want to see a repeat of last year's loss of HK$90m. In the meantime, we consider the stock to be risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that Tongda Hong Tai Holdings is showing 3 warning signs in our investment analysis , and 2 of those are significant...

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. 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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