We Think Ten Ren Tea (TPE:1233) Can Stay On Top Of Its 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 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 Ten Ren Tea Co., Ltd. (TPE:1233) 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?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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, 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.

See our latest analysis for Ten Ren Tea

What Is Ten Ren Tea's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Ten Ren Tea had NT$275.0m of debt, an increase on NT$110.0m, over one year. However, it does have NT$341.9m in cash offsetting this, leading to net cash of NT$66.9m.

A Look At Ten Ren Tea's Liabilities

Zooming in on the latest balance sheet data, we can see that Ten Ren Tea had liabilities of NT$624.7m due within 12 months and liabilities of NT$340.1m due beyond that. Offsetting these obligations, it had cash of NT$341.9m as well as receivables valued at NT$189.9m due within 12 months. So its liabilities total NT$433.0m more than the combination of its cash and short-term receivables.

Of course, Ten Ren Tea has a market capitalization of NT$3.24b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Ten Ren Tea boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Ten Ren Tea if management cannot prevent a repeat of the 50% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But it is Ten Ren Tea'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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Ten Ren Tea 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. Over the last three years, Ten Ren Tea actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

Although Ten Ren Tea's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of NT$66.9m. The cherry on top was that in converted 147% of that EBIT to free cash flow, bringing in NT$269m. So we are not troubled with Ten Ren Tea's debt use. 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 3 warning signs we've spotted with Ten Ren Tea (including 1 which is doesn't sit too well with us) .

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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