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We Think Tencent Music Entertainment Group (NYSE:TME) Can Manage Its Debt With Ease

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  • TME

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Tencent Music Entertainment Group (NYSE:TME) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. 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. 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.

View our latest analysis for Tencent Music Entertainment Group

What Is Tencent Music Entertainment Group's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Tencent Music Entertainment Group had CN¥5.15b of debt in September 2021, down from CN¥5.40b, one year before. But it also has CN¥20.2b in cash to offset that, meaning it has CN¥15.1b net cash.

debt-equity-history-analysis
debt-equity-history-analysis

A Look At Tencent Music Entertainment Group's Liabilities

According to the last reported balance sheet, Tencent Music Entertainment Group had liabilities of CN¥9.96b due within 12 months, and liabilities of CN¥5.82b due beyond 12 months. Offsetting these obligations, it had cash of CN¥20.2b as well as receivables valued at CN¥2.69b due within 12 months. So it actually has CN¥7.15b more liquid assets than total liabilities.

This surplus suggests that Tencent Music Entertainment Group has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Tencent Music Entertainment Group has more cash than debt is arguably a good indication that it can manage its debt safely.

But the other side of the story is that Tencent Music Entertainment Group saw its EBIT decline by 6.3% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Tencent Music Entertainment Group can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Tencent Music Entertainment Group may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Happily for any shareholders, Tencent Music Entertainment Group actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While it is always sensible to investigate a company's debt, in this case Tencent Music Entertainment Group has CN¥15.1b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥5.8b, being 167% of its EBIT. So we don't think Tencent Music Entertainment Group's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Tencent Music Entertainment Group is showing 1 warning sign in our investment analysis , you should know about...

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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