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Tree Holdings (HKG:8395) Has A Somewhat Strained Balance Sheet

Simply Wall St

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Tree Holdings Limited (HKG:8395) does carry debt. But should shareholders be worried about its use of debt?

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. If things get really bad, the lenders can take control of the business. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Tree Holdings

What Is Tree Holdings's Debt?

As you can see below, Tree Holdings had HK$469.0k of debt at March 2019, down from HK$5.34m a year prior. However, its balance sheet shows it holds HK$29.2m in cash, so it actually has HK$28.7m net cash.

SEHK:8395 Historical Debt, September 6th 2019

How Strong Is Tree Holdings's Balance Sheet?

The latest balance sheet data shows that Tree Holdings had liabilities of HK$23.4m due within a year, and liabilities of HK$27.9m falling due after that. Offsetting this, it had HK$29.2m in cash and HK$24.9m in receivables that were due within 12 months. So it actually has HK$2.81m more liquid assets than total liabilities.

This surplus suggests that Tree Holdings has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Tree Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Tree Holdings if management cannot prevent a repeat of the 62% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Tree Holdings will need earnings to service that debt. 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. Tree 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. During the last three years, Tree Holdings burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing up

While it is always sensible to investigate a company's debt, in this case Tree Holdings has HK$29m in net cash and a decent-looking balance sheet. So although we see some areas for improvement, we're not too worried about Tree Holdings's balance sheet. In light of our reservations about the company's balance sheet, it seems sensible to check if insiders have been selling shares recently.

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.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.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. Thank you for reading.