The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital. When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Tempus Holdings Limited (HKG:6880) does carry debt. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does Tempus Holdings Carry?
You can click the graphic below for the historical numbers, but it shows that Tempus Holdings had HK$489.5m of debt in June 2019, down from HK$565.4m, one year before. However, it does have HK$74.4m in cash offsetting this, leading to net debt of about HK$415.1m.
How Healthy Is Tempus Holdings's Balance Sheet?
The latest balance sheet data shows that Tempus Holdings had liabilities of HK$512.3m due within a year, and liabilities of HK$201.1m falling due after that. Offsetting this, it had HK$74.4m in cash and HK$223.1m in receivables that were due within 12 months. So it has liabilities totalling HK$415.9m more than its cash and near-term receivables, combined.
When you consider that this deficiency exceeds the company's HK$331.8m market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. 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 Tempus Holdings 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, Tempus Holdings reported revenue of HK$881m, which is a gain of 5.5%, although it did not report any earnings before interest and tax. That rate of growth is a bit slow for our taste, but it takes all types to make a world.
Over the last twelve months Tempus Holdings produced an earnings before interest and tax (EBIT) loss. Indeed, it lost a very considerable HK$70m at the EBIT level. When we look at that alongside the significant liabilities, we're not particularly confident about the company. It would need to improve its operations quickly for us to be interested in it. It's fair to say the loss of HK$104m didn't encourage us either; we'd like to see a profit. In the meantime, we consider the stock to be risky. For riskier companies like Tempus Holdings I always like to keep an eye on the long term profit and revenue trends. Fortunately, you can click to see our interactive graph of its profit, revenue, and operating cashflow.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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