Is Tong Ren Tang Technologies (HKG:1666) Using Too Much Debt?

Simply Wall St · 6d ago

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.' 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. Importantly, Tong Ren Tang Technologies Co. Ltd. (HKG:1666) does carry debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 Tong Ren Tang Technologies

What Is Tong Ren Tang Technologies's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2024 Tong Ren Tang Technologies had debt of CN¥2.24b, up from CN¥1.46b in one year. However, it does have CN¥4.36b in cash offsetting this, leading to net cash of CN¥2.13b.

debt-equity-history-analysis
SEHK:1666 Debt to Equity History September 28th 2024

How Healthy Is Tong Ren Tang Technologies' Balance Sheet?

According to the last reported balance sheet, Tong Ren Tang Technologies had liabilities of CN¥2.49b due within 12 months, and liabilities of CN¥1.95b due beyond 12 months. Offsetting this, it had CN¥4.36b in cash and CN¥1.23b in receivables that were due within 12 months. So it actually has CN¥1.15b more liquid assets than total liabilities.

This surplus suggests that Tong Ren Tang Technologies is using debt in a way that is appears to be both safe and conservative. Due to its strong net asset position, it is not likely to face issues with its lenders. Succinctly put, Tong Ren Tang Technologies boasts net cash, so it's fair to say it does not have a heavy debt load!

On the other hand, Tong Ren Tang Technologies's EBIT dived 14%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Tong Ren Tang Technologies's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Tong Ren Tang Technologies has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. In the last three years, Tong Ren Tang Technologies's free cash flow amounted to 28% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Tong Ren Tang Technologies has net cash of CN¥2.13b, as well as more liquid assets than liabilities. So we are not troubled with Tong Ren Tang Technologies's debt use. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 2 warning signs for Tong Ren Tang Technologies (1 doesn't sit too well with us) you should be aware of.

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.