Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies TUS ENVIRONMENTAL SCIENCE AND TECHNOLOGY DEVELOPMENT Co., LTD. (SZSE:000826) makes use of debt. But is this debt a concern to shareholders?
When Is Debt Dangerous?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
See our latest analysis for TUS ENVIRONMENTAL SCIENCE AND TECHNOLOGY DEVELOPMENT
How Much Debt Does TUS ENVIRONMENTAL SCIENCE AND TECHNOLOGY DEVELOPMENT Carry?
You can click the graphic below for the historical numbers, but it shows that TUS ENVIRONMENTAL SCIENCE AND TECHNOLOGY DEVELOPMENT had CN¥8.11b of debt in September 2023, down from CN¥8.77b, one year before. On the flip side, it has CN¥743.3m in cash leading to net debt of about CN¥7.37b.
How Healthy Is TUS ENVIRONMENTAL SCIENCE AND TECHNOLOGY DEVELOPMENT's Balance Sheet?
We can see from the most recent balance sheet that TUS ENVIRONMENTAL SCIENCE AND TECHNOLOGY DEVELOPMENT had liabilities of CN¥7.48b falling due within a year, and liabilities of CN¥7.69b due beyond that. Offsetting these obligations, it had cash of CN¥743.3m as well as receivables valued at CN¥5.35b due within 12 months. So its liabilities total CN¥9.07b more than the combination of its cash and short-term receivables.
This deficit casts a shadow over the CN¥3.79b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, TUS ENVIRONMENTAL SCIENCE AND TECHNOLOGY DEVELOPMENT would probably need a major re-capitalization if its creditors were to demand repayment.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Weak interest cover of 0.12 times and a disturbingly high net debt to EBITDA ratio of 8.5 hit our confidence in TUS ENVIRONMENTAL SCIENCE AND TECHNOLOGY DEVELOPMENT like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. Even worse, TUS ENVIRONMENTAL SCIENCE AND TECHNOLOGY DEVELOPMENT saw its EBIT tank 67% over the last 12 months. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since TUS ENVIRONMENTAL SCIENCE AND TECHNOLOGY DEVELOPMENT 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, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. Happily for any shareholders, TUS ENVIRONMENTAL SCIENCE AND TECHNOLOGY DEVELOPMENT actually produced more free cash flow than EBIT over the last two years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
Our View
To be frank both TUS ENVIRONMENTAL SCIENCE AND TECHNOLOGY DEVELOPMENT's EBIT growth rate and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. After considering the datapoints discussed, we think TUS ENVIRONMENTAL SCIENCE AND TECHNOLOGY DEVELOPMENT has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. 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, we've discovered 1 warning sign for TUS ENVIRONMENTAL SCIENCE AND TECHNOLOGY DEVELOPMENT that you should be aware of before investing here.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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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.