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Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. Importantly, Tencent Holdings Limited (HKG:700) does carry debt. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
See our latest analysis for Tencent Holdings
What Is Tencent Holdings's Debt?
The image below, which you can click on for greater detail, shows that at June 2019 Tencent Holdings had debt of CN¥200.2b, up from CN¥169.5b in one year. However, it also had CN¥184.5b in cash, and so its net debt is CN¥15.7b.
How Healthy Is Tencent Holdings's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Tencent Holdings had liabilities of CN¥201.9b due within 12 months and liabilities of CN¥193.9b due beyond that. Offsetting this, it had CN¥184.5b in cash and CN¥35.7b in receivables that were due within 12 months. So its liabilities total CN¥175.6b more than the combination of its cash and short-term receivables.
Of course, Tencent Holdings has a titanic market capitalization of CN¥2.96t, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Carrying virtually no net debt, Tencent Holdings has a very light debt load indeed.
In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Tencent Holdings has net debt of just 0.13 times EBITDA, suggesting it could ramp leverage without breaking a sweat. But the really cool thing is that it actually managed to receive more interest than it paid, over the last year. So there's no doubt this company can take on debt while staying cool as a cucumber. The good news is that Tencent Holdings has increased its EBIT by 8.6% over twelve months, which should ease any concerns about debt repayment. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Tencent Holdings'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.