Jiangsu Zhongchao Holding (SZSE:002471) Seems To Use Debt Quite Sensibly

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We note that Jiangsu Zhongchao Holding Co., Ltd. (SZSE:002471) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Jiangsu Zhongchao Holding

What Is Jiangsu Zhongchao Holding's Net Debt?

The image below, which you can click on for greater detail, shows that Jiangsu Zhongchao Holding had debt of CN¥1.85b at the end of March 2024, a reduction from CN¥1.97b over a year. On the flip side, it has CN¥601.8m in cash leading to net debt of about CN¥1.25b.

How Strong Is Jiangsu Zhongchao Holding's Balance Sheet?

According to the last reported balance sheet, Jiangsu Zhongchao Holding had liabilities of CN¥3.51b due within 12 months, and liabilities of CN¥92.5m due beyond 12 months. On the other hand, it had cash of CN¥601.8m and CN¥2.50b worth of receivables due within a year. So it has liabilities totalling CN¥503.9m more than its cash and near-term receivables, combined.

Since publicly traded Jiangsu Zhongchao Holding shares are worth a total of CN¥3.71b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Weak interest cover of 0.86 times and a disturbingly high net debt to EBITDA ratio of 9.1 hit our confidence in Jiangsu Zhongchao Holding like a one-two punch to the gut. The debt burden here is substantial. One redeeming factor for Jiangsu Zhongchao Holding is that it turned last year's EBIT loss into a gain of CN¥78m, over the last twelve months. 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 Jiangsu Zhongchao Holding will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Happily for any shareholders, Jiangsu Zhongchao Holding actually produced more free cash flow than EBIT over the last year. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

Jiangsu Zhongchao Holding's interest cover was a real negative on this analysis, as was its net debt to EBITDA. But its conversion of EBIT to free cash flow was significantly redeeming. When we consider all the factors mentioned above, we do feel a bit cautious about Jiangsu Zhongchao Holding's use of debt. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 4 warning signs for Jiangsu Zhongchao Holding (1 doesn't sit too well with us) you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.