Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 note that Tencent Music Entertainment Group (NYSE:TME) does have debt on its balance sheet. But is this debt a concern to shareholders?
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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 examine debt levels, we first consider both cash and debt levels, together.
What Is Tencent Music Entertainment Group's Debt?
You can click the graphic below for the historical numbers, but it shows that as of March 2021 Tencent Music Entertainment Group had CN¥5.21b of debt, an increase on none, over one year. However, its balance sheet shows it holds CN¥23.6b in cash, so it actually has CN¥18.3b net cash.
How Healthy Is Tencent Music Entertainment Group's Balance Sheet?
We can see from the most recent balance sheet that Tencent Music Entertainment Group had liabilities of CN¥9.47b falling due within a year, and liabilities of CN¥5.89b due beyond that. On the other hand, it had cash of CN¥23.6b and CN¥2.82b worth of receivables due within a year. So it can boast CN¥11.0b more liquid assets than total liabilities.
This surplus suggests that Tencent Music Entertainment Group has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Tencent Music Entertainment Group has more cash than debt is arguably a good indication that it can manage its debt safely.
Fortunately, Tencent Music Entertainment Group grew its EBIT by 5.6% in the last year, making that debt load look even more manageable. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Tencent Music Entertainment Group 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. While Tencent Music Entertainment Group 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. Over the last three years, Tencent Music Entertainment Group actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
While it is always sensible to investigate a company's debt, in this case Tencent Music Entertainment Group has CN¥18.3b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 175% of that EBIT to free cash flow, bringing in CN¥5.2b. So we don't think Tencent Music Entertainment Group's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 1 warning sign we've spotted with Tencent Music Entertainment Group .
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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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