Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. We note that Tangrenshen Group Co., Ltd (SZSE:002567) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Tangrenshen Group's Debt?
The image below, which you can click on for greater detail, shows that at September 2023 Tangrenshen Group had debt of CN¥7.68b, up from CN¥6.14b in one year. However, it does have CN¥2.96b in cash offsetting this, leading to net debt of about CN¥4.72b.
How Healthy Is Tangrenshen Group's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Tangrenshen Group had liabilities of CN¥6.27b due within 12 months and liabilities of CN¥6.08b due beyond that. Offsetting this, it had CN¥2.96b in cash and CN¥594.3m in receivables that were due within 12 months. So its liabilities total CN¥8.80b more than the combination of its cash and short-term receivables.
Given this deficit is actually higher than the company's market capitalization of CN¥8.48b, we think shareholders really should watch Tangrenshen Group'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 it is future earnings, more than anything, that will determine Tangrenshen Group's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Over 12 months, Tangrenshen Group reported revenue of CN¥29b, which is a gain of 19%, although it did not report any earnings before interest and tax. We usually like to see faster growth from unprofitable companies, but each to their own.
Caveat Emptor
Over the last twelve months Tangrenshen Group produced an earnings before interest and tax (EBIT) loss. To be specific the EBIT loss came in at CN¥535m. Considering that alongside the liabilities mentioned above make us nervous about the company. It would need to improve its operations quickly for us to be interested in it. Not least because it had negative free cash flow of CN¥1.3b over the last twelve months. That means it's on the risky side of things. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 2 warning signs for Tangrenshen Group (1 can't be ignored!) that you should be aware of before investing here.
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.
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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.