Howard Marks put it nicely when he said that, rather than worrying about share price volatility, ‘The possibility of permanent loss is the risk I worry about… and every practical investor I know worries about.’ It’s only natural to consider a company’s balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that China Tianrui Automotive Interiors Co., LTD (HKG:6162) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
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. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.
Check out the opportunities and risks within the HK Auto Components industry.
What Is China Tianrui Automotive Interiors’s Debt?
As you can see below, at the end of June 2022, China Tianrui Automotive Interiors had CN¥141.4m of debt, up from CN¥98.7m a year ago. Click the image for more detail. However, because it has a cash reserve of CN¥59.6m, its net debt is less, at about CN¥81.8m.
How Strong Is China Tianrui Automotive Interiors’ Balance Sheet?
Zooming in on the latest balance sheet data, we can see that China Tianrui Automotive Interiors had liabilities of CN¥228.9m due within 12 months and liabilities of CN¥16.5m due beyond that. On the other hand, it had cash of CN¥59.6m and CN¥139.4m worth of receivables due within a year. So its liabilities total CN¥46.4m more than the combination of its cash and short-term receivables.
This deficit isn’t so bad because China Tianrui Automotive Interiors is worth CN¥197.9m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. When analysing debt levels, the balance sheet is the obvious place to start. But you can’t view debt in total isolation; since China Tianrui Automotive Interiors will need earnings to service that debt. So when considering debt, it’s definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Over 12 months, China Tianrui Automotive Interiors made a loss at the EBIT level, and saw its revenue drop to CN¥157m, which is a fall of 62%. To be frank that doesn’t bode well.
Not only did China Tianrui Automotive Interiors’s revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost a very considerable CN¥23m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. We would feel better if it turned its trailing twelve month loss of CN¥27m into a profit. In the meantime, we consider the stock very risky. 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. We’ve identified 2 warning signs with China Tianrui Automotive Interiors (at least 1 which shouldn’t be ignored) , and understanding them should be part of your investment process.
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.