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.' 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. We can see that Tianma Microelectronics Co., Ltd. (SZSE:000050) 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 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
View our latest analysis for Tianma Microelectronics
How Much Debt Does Tianma Microelectronics Carry?
The image below, which you can click on for greater detail, shows that at September 2023 Tianma Microelectronics had debt of CN¥37.4b, up from CN¥35.9b in one year. However, because it has a cash reserve of CN¥9.15b, its net debt is less, at about CN¥28.3b.
How Healthy Is Tianma Microelectronics' Balance Sheet?
We can see from the most recent balance sheet that Tianma Microelectronics had liabilities of CN¥21.5b falling due within a year, and liabilities of CN¥31.2b due beyond that. On the other hand, it had cash of CN¥9.15b and CN¥8.09b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥35.5b.
Given this deficit is actually higher than the company's market capitalization of CN¥25.6b, we think shareholders really should watch Tianma Microelectronics's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Tianma Microelectronics 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.
In the last year Tianma Microelectronics had a loss before interest and tax, and actually shrunk its revenue by 2.1%, to CN¥32b. We would much prefer see growth.
Caveat Emptor
Importantly, Tianma Microelectronics had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost a very considerable CN¥2.7b at the EBIT level. Considering that alongside the liabilities mentioned above make us nervous about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. For example, we would not want to see a repeat of last year's loss of CN¥2.0b. And until that time we think this is a risky stock. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example - Tianma Microelectronics has 1 warning sign we think you should be aware of.
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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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using 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 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.