Is Tongcheng Travel Holdings (HKG:780) Using Too Much Debt?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. As with many other companies Tongcheng Travel Holdings Limited (HKG:780) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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.

Check out our latest analysis for Tongcheng Travel Holdings

What Is Tongcheng Travel Holdings's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 Tongcheng Travel Holdings had CN¥3.12b of debt, an increase on CN¥2.18b, over one year. However, it does have CN¥10.2b in cash offsetting this, leading to net cash of CN¥7.04b.

How Strong Is Tongcheng Travel Holdings' Balance Sheet?

We can see from the most recent balance sheet that Tongcheng Travel Holdings had liabilities of CN¥12.9b falling due within a year, and liabilities of CN¥2.19b due beyond that. Offsetting this, it had CN¥10.2b in cash and CN¥2.14b in receivables that were due within 12 months. So its liabilities total CN¥2.78b more than the combination of its cash and short-term receivables.

Given Tongcheng Travel Holdings has a market capitalization of CN¥40.4b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Tongcheng Travel Holdings also has more cash than debt, so we're pretty confident it can manage its debt safely.

Even more impressive was the fact that Tongcheng Travel Holdings grew its EBIT by 112% over twelve months. That boost will make it even easier to pay down debt going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Tongcheng Travel Holdings can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Tongcheng Travel 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. Over the last three years, Tongcheng Travel Holdings actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Tongcheng Travel Holdings has CN¥7.04b in net cash. The cherry on top was that in converted 154% of that EBIT to free cash flow, bringing in CN¥2.0b. So is Tongcheng Travel Holdings's debt a risk? It doesn't seem so to us. 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 Tongcheng Travel Holdings is showing 1 warning sign 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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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.