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 Tian Teck Land Limited (HKG:266) makes use of debt. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does Tian Teck Land Carry?
As you can see below, Tian Teck Land had HK$201.8m of debt, at September 2019, which is about the same the year before. You can click the chart for greater detail. But on the other hand it also has HK$782.8m in cash, leading to a HK$581.0m net cash position.
How Healthy Is Tian Teck Land's Balance Sheet?
According to the last reported balance sheet, Tian Teck Land had liabilities of HK$461.8m due within 12 months, and liabilities of HK$285.9m due beyond 12 months. Offsetting this, it had HK$782.8m in cash and HK$21.8m in receivables that were due within 12 months. So it can boast HK$56.9m more liquid assets than total liabilities.
This state of affairs indicates that Tian Teck Land's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the HK$3.36b company is short on cash, but still worth keeping an eye on the balance sheet. Succinctly put, Tian Teck Land boasts net cash, so it's fair to say it does not have a heavy debt load!
But the other side of the story is that Tian Teck Land saw its EBIT decline by 3.6% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Tian Teck Land's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Tian Teck Land 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, Tian Teck Land recorded free cash flow worth a fulsome 84% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.
While it is always sensible to investigate a company's debt, in this case Tian Teck Land has HK$581.0m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 84% of that EBIT to free cash flow, bringing in HK$389m. So is Tian Teck Land's debt a risk? It doesn't seem so to us. 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. Take risks, for example - Tian Teck Land has 2 warning signs (and 1 which can't be ignored) we think you should know about.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
If you spot an error that warrants correction, please contact the editor at email@example.com. 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.
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