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 price volatility, but whether you will suffer a permanent loss of capital.” So it seems the smart money knows that debt – which is often involved in bankruptcies – is a very important factor when evaluating how risky a company is. As with many other companies Tongcheng Travel Holdings Limited (HKG:780) makes use of debt. But is this debt a concern for shareholders?
When is debt a problem?
Debt is a tool to help businesses grow, but if a business is unable to pay its creditors then it is at their mercy. In the worst case scenario, a company could go bankrupt if it is unable to pay its creditors. While this is not very common, we often see indebted companies permanently diluting shareholders because creditors force them to raise capital at a difficult price. Of course, many companies turn to debt to finance growth without any negative consequences. When we think about a company’s use of debt, we first look at cash and debt together.
See our latest analysis for Tongcheng Travel Holdings
How much debt does Tongcheng Travel Holdings carry?
As you can see below, at the end of March 2024, Tongcheng Travel Holdings had CN¥3.38 billion in debt, up from CN¥1.97 billion the previous year. Click on the image for more details. But it also has CN¥10.0 billion in cash to offset that, which means it has CN¥6.64 billion in liquid cash.
An Analysis of Tongcheng Travel Holdings’ Responsibilities
Zooming in on the latest balance sheet data, we can see that Tongcheng Travel Holdings had liabilities of CN¥12.6b due within 12 months, and liabilities of CN¥2.11b due beyond that. Offsetting this, it had CN¥10.0 billion in cash and CN¥1.48 billion in receivables due within 12 months. So its liabilities total CN¥3.22 billion more than the combination of its cash and short-term receivables.
Since Tongcheng Travel Holdings’ publicly traded shares are worth a total of CN¥37.1 billion, it seems unlikely that this level of liabilities would be a major threat. However, we think it’s worth keeping an eye on the strength of its balance sheet, as it can change over time. While it has noteworthy liabilities, Tongcheng Travel Holdings also has more cash than debt, so we’re pretty confident it can manage its debt safely.
Even more impressive was the fact that Tongcheng Travel Holdings increased its EBIT by 476% in twelve months. This boost will make paying off your debt in the future even easier. When analyzing debt levels, the balance sheet is the obvious starting point. But it is future profits, more than anything, that will determine Tongcheng Travel Holdings’ ability to maintain a healthy balance sheet in the future. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
But our final consideration is also important, because a company cannot pay debts with paper profits; need cash. Tongcheng Travel Holdings may have net cash on the balance sheet, but it is still interesting to see how well the company converts its earnings before interest and taxes (EBIT) into free cash flow, because this will influence both its need and its ability to manage debt. Over the last three years, Tongcheng Travel Holdings actually produced more free cash flow than EBIT. There’s nothing better than getting paid when it comes to staying in your creditors’ good graces.
In short
We could understand if investors are worried about Tongcheng Travel Holdings’ liabilities, but we can rest assured that it has net cash of CN¥6.64b. The icing on the cake was that we converted 165% of this EBIT into free cash flow, generating CN¥ 2.8 billion. Therefore, we don’t think Tongcheng Travel Holdings’ use of debt is risky. When analyzing debt levels, the balance sheet is the obvious starting point. But ultimately, all companies can contain risks that exist outside the balance sheet. For example, we identified 1 Warning Sign for Tongcheng Travel Holdings that you should be aware of.
If, after all this, 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.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take into account your objectives or financial situation. Our goal is to bring you long-term focused analysis driven by fundamental data. Please note that our analysis may not take into account the latest price-sensitive company announcements or qualitative materials. Simply Wall St has no position in any of the stocks mentioned.
