Is Tian Lun Gas Holdings (HKG:1600) a risky investment?
David Iben said it well when he said: “Volatility is not a risk that interests us. What matters to us is to avoid the permanent loss of capital. So it seems smart money knows that debt – which is usually involved in bankruptcies – is a very important factor when you’re assessing a company’s risk. We can see that Tian Lun Gas Holdings Limited (HKG:1600) uses debt in his business. But should shareholders worry about its use of debt?
When is debt a problem?
Generally speaking, debt only becomes a real problem when a company cannot easily repay it, either by raising capital or with its own cash flow. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is when a company has to dilute shareholders at a cheap share price just to keep debt under control. Of course, debt can be an important tool in businesses, especially capital-intensive businesses. When we think about a company’s use of debt, we first look at cash and debt together.
Check out our latest analysis for Tian Lun Gas Holdings
How much debt does Tian Lun Gas Holdings have?
You can click on the graph below for historical figures, but it shows that in June 2022, Tian Lun Gas Holdings had a debt of 7.21 billion Canadian yen, an increase from 5.65 billion yen Canadians, over one year. However, he also had 1.17 billion yen in cash, so his net debt is 6.04 billion yen.
How strong is Tian Lun Gas Holdings’ balance sheet?
According to the latest published balance sheet, Tian Lun Gas Holdings had liabilities of 3.95 billion Canadian yen due within 12 months and liabilities of 6.10 billion domestic yen due beyond 12 months. In return, he had 1.17 billion Canadian yen in cash and 3.63 billion domestic yen in debt due within 12 months. Thus, its liabilities outweigh the sum of its cash and (short-term) receivables of 5.25 billion Canadian yen.
This deficit casts a shadow over the CN¥3.07b company, like a colossus towering above mere mortals. We would therefore be watching his balance sheet closely, no doubt. Ultimately, Tian Lun Gas Holdings would likely need a major recapitalization if its creditors were to demand repayment.
We measure a company’s leverage against its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT ) covers its interest charge (interest coverage). Thus, we consider debt to earnings with and without amortization and depreciation expense.
Tian Lun Gas Holdings has a debt to EBITDA ratio of 3.9 and its EBIT covered its interest expense 5.0 times. This suggests that while debt levels are significant, we will refrain from labeling them as problematic. Unfortunately, Tian Lun Gas Holdings’ EBIT has dropped 20% in the past four quarters. If that kind of decline isn’t stopped, then managing his debt will be harder than selling broccoli-flavored ice cream for a bounty. The balance sheet is clearly the area to focus on when analyzing debt. But ultimately, the company’s future profitability will decide whether Tian Lun Gas Holdings can strengthen its balance sheet over time. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.
Finally, a company can only repay its debts with cold hard cash, not with book profits. We must therefore clearly examine whether this EBIT generates a corresponding free cash flow. Over the past three years, Tian Lun Gas Holdings has produced strong free cash flow equivalent to 53% of its EBIT, which is what we expected. This free cash flow puts the company in a good position to repay its debt, should it arise.
Our point of view
At first glance, Tian Lun Gas Holdings’ EBIT growth rate left us hesitant about the stock, and its level of total liabilities was no more attractive than the single empty restaurant on the busiest night in the year. But at least it’s decent enough to convert EBIT to free cash flow; it’s encouraging. It should also be noted that companies in the gas utility sector like Tian Lun Gas Holdings generally use debt without a problem. We are quite clear that we consider Tian Lun Gas Holdings to be quite risky indeed, given the health of its balance sheet. We are therefore almost as suspicious of this stock as a hungry kitten of falling into its owner’s fish pond: once bitten, twice shy, as they say. The balance sheet is clearly the area to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist outside of the balance sheet. For example, we found 3 warning signs for Tian Lun Gas Holdings (1 is concerning!) that you should be aware of before investing here.
In the end, it’s often best to focus on companies that aren’t in debt. You can access our special list of these companies (all with a track record of earnings growth). It’s free.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.
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