The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. We can see that Tsui Wah Holdings Limited (HKG:1314) does use debt in its business. But the real question is whether this debt is making the company risky.
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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.
What Is Tsui Wah Holdings's Net Debt?
The image below, which you can click on for greater detail, shows that Tsui Wah Holdings had debt of HK$63.0m at the end of March 2019, a reduction from HK$67.6m over a year. However, its balance sheet shows it holds HK$424.5m in cash, so it actually has HK$361.5m net cash.
How Healthy Is Tsui Wah Holdings's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Tsui Wah Holdings had liabilities of HK$280.0m due within 12 months and liabilities of HK$44.1m due beyond that. On the other hand, it had cash of HK$424.5m and HK$12.3m worth of receivables due within a year. So it can boast HK$112.7m more liquid assets than total liabilities.
This excess liquidity suggests that Tsui Wah Holdings is taking a careful approach to debt. Due to its strong net asset position, it is not likely to face issues with its lenders. Succinctly put, Tsui Wah Holdings boasts net cash, so it's fair to say it does not have a heavy debt load! 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 Tsui Wah Holdings'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.
In the last year Tsui Wah Holdings had negative earnings before interest and tax, and actually shrunk its revenue by 2.6%, to HK$1.8b. We would much prefer see growth.
So How Risky Is Tsui Wah Holdings?
While Tsui Wah Holdings lost money on an earnings before interest and tax (EBIT) level, it actually booked a paper profit of HK$4.7m. So taking that on face value, and considering the cash, we don't think its very risky in the near term. We'll feel more comfortable with the stock once EBIT is positive, given the lacklustre revenue growth. When we look at a riskier company, we like to check how their profits (or losses) are trending over time. Today, we're providing readers this interactive graph showing how Tsui Wah Holdings's profit, revenue, and operating cashflow have changed over the last few years.
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.
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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.