Howard Marks said it well when he said that, rather than worrying about stock price volatility, “the possibility of permanent loss is the risk I worry about…and that every practical investor that I know is worried”. 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 Taste Gourmet Group Limited (HKG:8371) uses debt in his business. But the more important question is: what risk does this debt create?
What risk does debt carry?
Debt helps a business until the business struggles to pay it back, either with new capital or with free cash flow. If things go really bad, lenders can take over the business. 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 look at debt levels, we first consider cash and debt levels, together.
See our latest review for Taste Gourmet Group
What is Taste Gourmet Group’s net debt?
You can click on the graph below for historical figures, but it shows that in September 2021, the Taste Gourmet Group had a debt of HK$281.6 million, an increase from HK$764.0k , over one year. On the other hand, he has HK$98.7 million in cash, resulting in a net debt of around HK$182.9 million.
How strong is Taste Gourmet Group’s balance sheet?
Zooming in on the latest balance sheet data, we can see that Taste Gourmet Group had liabilities of HK$138.0 million due within 12 months and liabilities of HK$210.8 million due beyond. On the other hand, it had cash of HK$98.7 million and HK$25.4 million of receivables due within one year. It therefore has liabilities totaling HK$224.7 million more than its cash and short-term receivables, combined.
This shortfall is sizable compared to its market capitalization of HK$270.9 million, so it suggests shareholders should monitor Taste Gourmet Group’s use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet quickly.
We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). Thus, we consider debt to earnings with and without amortization and depreciation expense.
Taste Gourmet Group’s net debt is at a very reasonable 2.3 times its EBITDA, while its EBIT covered its interest expense at just 6.8 times last year. While these numbers don’t alarm us, it’s worth noting that the cost of corporate debt has a real impact. Fortunately, Taste Gourmet Group is growing its EBIT faster than former Australian Prime Minister Bob Hawke lowered a yard glass, with a 408% gain over the last twelve months. The balance sheet is clearly the area to focus on when analyzing debt. But you can’t look at debt in total isolation; since Taste Gourmet Group will need income to repay this debt. So, if you want to know more about its earnings, it may be worth checking out this graph of its long-term trend.
But our last consideration is also important, because a company cannot pay debt with paper profits; he needs cash. We must therefore clearly examine whether this EBIT generates a corresponding free cash flow. Over the past three years, Taste Gourmet Group has actually produced more free cash flow than EBIT. There’s nothing better than incoming money to stay in the good books of your lenders.
Our point of view
The good news is that Taste Gourmet Group’s demonstrated ability to convert EBIT into free cash flow delights us like a fluffy puppy does a toddler. But truth be told, we think his total passive level undermines that impression a bit. All told, it looks like Taste Gourmet Group can comfortably manage its current level of debt. On the plus side, this leverage can increase shareholder returns, but the potential downside is more risk of loss, so it’s worth keeping an eye on the balance sheet. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risks reside on the balance sheet, far from it. These risks can be difficult to spot. Every business has them, and we’ve spotted 5 warning signs for Taste Gourmet Group you should know.
If, after all that, you’re more interested in a fast-growing company with a strong balance sheet, check out our list of cash-flowing growth stocks without further ado.
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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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