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

Warren Buffett famously said, '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. We can see that Tongda Hong Tai Holdings Limited (HKG:2363) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. 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. 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. 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 Tongda Hong Tai Holdings

What Is Tongda Hong Tai Holdings's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Tongda Hong Tai Holdings had HK$236.7m of debt in June 2021, down from HK$276.0m, one year before. 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

According to the last reported balance sheet, Tongda Hong Tai Holdings had liabilities of HK$413.4m due within 12 months, and liabilities of HK$6.83m due beyond 12 months. On the other hand, it had cash of HK$10.5m and HK$153.8m worth of receivables due within a year. So its liabilities total HK$255.9m more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the HK$47.9m 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'd watch its balance sheet closely, without a doubt. After all, Tongda Hong Tai Holdings would likely require a major re-capitalisation if it had to pay its creditors today. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Tongda Hong Tai Holdings 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.

Over 12 months, Tongda Hong Tai Holdings made a loss at the EBIT level, and saw its revenue drop to HK$452m, which is a fall of 3.4%. 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$108m. Combining this information with the significant liabilities we already touched on makes us very hesitant about this stock, to say the least. Of course, it may be able to improve its situation with a bit of luck and good execution. 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. 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. To that end, you should learn about the 4 warning signs we've spotted with Tongda Hong Tai Holdings (including 2 which are potentially serious) .

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.
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