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.’ 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. We note that Harmonicare Medical Holdings Limited (HKG:1509) does have debt on its balance sheet. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
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. Ultimately, if the company can’t fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company’s use of debt, we first look at cash and debt together.
What Is Harmonicare Medical Holdings’s Debt?
The image below, which you can click on for greater detail, shows that at December 2018 Harmonicare Medical Holdings had debt of CN¥80.4m, up from CN¥500.0k in one year. But it also has CN¥130.3m in cash to offset that, meaning it has CN¥49.9m net cash.
How Healthy Is Harmonicare Medical Holdings’s Balance Sheet?
The latest balance sheet data shows that Harmonicare Medical Holdings had liabilities of CN¥296.0m due within a year, and liabilities of CN¥154.8m falling due after that. Offsetting this, it had CN¥130.3m in cash and CN¥89.5m in receivables that were due within 12 months. So it has liabilities totalling CN¥231.1m more than its cash and near-term receivables, combined.
Given Harmonicare Medical Holdings has a market capitalization of CN¥1.33b, it’s hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Harmonicare Medical Holdings boasts net cash, so it’s fair to say it does not have a heavy debt load! There’s no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Harmonicare Medical 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.
Over 12 months, Harmonicare Medical Holdings reported revenue of CN¥1.0b, which is a gain of 9.2%. We usually like to see faster growth from unprofitable companies, but each to their own.
So How Risky Is Harmonicare Medical Holdings?
We have no doubt that loss making companies are, in general, riskier than profitable ones. And in the last year Harmonicare Medical Holdings had negative earnings before interest and tax (EBIT), truth be told. And over the same period it saw negative free cash outflow of CN¥257m and booked a CN¥199m accounting loss. Given it only has net cash of CN¥130m, the company may need to raise more capital if it doesn’t reach break-even soon. Overall, we’d say the stock is a bit risky, and we’re usually very cautious until we see positive free cash flow. For riskier companies like Harmonicare Medical 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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