China Tangshang Holdings (HKG: 674) Takes Risks With Its Use of Debt
Berkshire Hathaway’s Charlie Munger-backed external fund manager Li Lu is quick to say this when he says “The biggest risk in investing is not price volatility, but if you will suffer a loss. permanent capital “. So it seems like smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess the level of risk of a business. We notice that China Tangshang Holdings Limited (HKG: 674) has debt on its balance sheet. But should shareholders be concerned about its use of debt?
When is Debt a Problem?
Debt helps a business until the business struggles to repay it, either with new capital or with free cash flow. If things really go wrong, lenders can take over the business. However, a more common (but still painful) scenario is that he has to raise new equity at low cost, thereby constantly diluting shareholders. By replacing dilution, however, debt can be a very good tool for companies 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 flow and debt together.
Check out our latest analysis for China Tangshang Holdings
What is the net debt of China Tangshang Holdings?
As you can see below, China Tangshang Holdings was in debt of HK $ 270.1million in September 2021, up from HK $ 334.7million the year before. However, his balance sheet shows that he has HK $ 351.1million in cash, so he actually has net cash of HK $ 81.0million.
How strong is China Tangshang Holdings’ balance sheet?
We can see from the most recent balance sheet that China Tangshang Holdings had liabilities of HK $ 1.08 billion due within one year and liabilities of HK $ 509.7 million due beyond. On the other hand, he had HK $ 351.1 million in cash and HK $ 37.5 million in receivables due within one year. Its liabilities therefore total HK $ 1.21 billion more than the combination of its cash and short-term receivables.
The lack here weighs heavily on the HK $ 385.6million business itself, as if a child struggles under the weight of a huge backpack full of books, his gym equipment and a trumpet. We would therefore monitor its record closely, without a doubt. Ultimately, China Tangshang Holdings would likely need a major recapitalization if its creditors demanded repayment. Since China Tangshang Holdings has more cash than debt, we are quite confident that it can handle its debt, despite having a lot of liabilities in total.
The bad news is that China Tangshang Holdings has seen its EBIT drop by 18% in the past year. If incomes continue to decline at this rate, it will be more difficult to manage debt than taking three kids under 5 to a fancy pants restaurant. There is no doubt that we learn the most about debt from the balance sheet. But it is the earnings of China Tangshang Holdings that will influence balance sheet performance in the future. So if you want to know more about its profits, it may be worth checking out this long term profit trend chart.
Finally, a business needs free cash flow to pay off debts; accounting profits are not enough. Although China Tangshang Holdings has net cash on its balance sheet, it is still worth examining its ability to convert earnings before interest and taxes (EBIT) into free cash flow, to help us understand how fast it is building. (or erode) that cash balance. In the past two years, China Tangshang Holdings has actually generated more free cash flow than EBIT. This kind of cash conversion makes us as excited as the crowd when the beat drops at a Daft Punk concert.
Although China Tangshang Holdings has more liabilities than liquid assets, it also has net cash of HK $ 81.0 million. And he impressed us with free cash flow of HK $ 103million, or 526% of his EBIT. Despite the liquidity, we are concerned about the level of total liabilities of China Tangshang Holdings, so we are not particularly comfortable with the stock. When analyzing debt levels, the balance sheet is the obvious place to start. But at the end of the day, every business can contain risks that exist off the balance sheet. For example, we have identified 2 warning signs for China Tangshang Holdings that you need to be aware of.
Of course, if you are the type of investor who prefers to buy stocks without going into debt, feel free to check out our exclusive list of cash net growth stocks today.
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