These 4 Measures Indicate That Tian Yuan Group Holdings (HKG:6119) Is Using Debt Safely

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Tian Yuan Group Holdings Limited (HKG:6119) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Tian Yuan Group Holdings

What Is Tian Yuan Group Holdings's Net Debt?

The chart below, which you can click on for greater detail, shows that Tian Yuan Group Holdings had CN¥40.0m in debt in June 2020; about the same as the year before. But on the other hand it also has CN¥143.2m in cash, leading to a CN¥103.2m net cash position.

How Healthy Is Tian Yuan Group Holdings's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Tian Yuan Group Holdings had liabilities of CN¥58.9m due within 12 months and liabilities of CN¥654.0k due beyond that. Offsetting these obligations, it had cash of CN¥143.2m as well as receivables valued at CN¥17.2m due within 12 months. So it can boast CN¥100.9m more liquid assets than total liabilities.

This surplus liquidity suggests that Tian Yuan Group Holdings's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Simply put, the fact that Tian Yuan Group Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.

In addition to that, we're happy to report that Tian Yuan Group Holdings has boosted its EBIT by 46%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But it is Tian Yuan Group 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Tian Yuan Group Holdings may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Considering the last three years, Tian Yuan Group Holdings actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Tian Yuan Group Holdings has net cash of CN¥103.2m, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 46% over the last year. So is Tian Yuan Group Holdings's debt a risk? It doesn't seem so to us. 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. Be aware that Tian Yuan Group Holdings is showing 3 warning signs in our investment analysis , you should know about...

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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