Is Topchoice Medical (SHSE:600763) A Risky Investment?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Topchoice Medical Co., Inc. (SHSE:600763) makes use of debt. But the real question is whether this debt is making the company risky.

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

Check out our latest analysis for Topchoice Medical

How Much Debt Does Topchoice Medical Carry?

As you can see below, Topchoice Medical had CN¥370.8m of debt at March 2024, down from CN¥423.0m a year prior. But it also has CN¥510.1m in cash to offset that, meaning it has CN¥139.3m net cash.

How Strong Is Topchoice Medical's Balance Sheet?

We can see from the most recent balance sheet that Topchoice Medical had liabilities of CN¥512.6m falling due within a year, and liabilities of CN¥1.25b due beyond that. Offsetting these obligations, it had cash of CN¥510.1m as well as receivables valued at CN¥379.0m due within 12 months. So its liabilities total CN¥870.2m more than the combination of its cash and short-term receivables.

Since publicly traded Topchoice Medical shares are worth a total of CN¥18.6b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Topchoice Medical also has more cash than debt, so we're pretty confident it can manage its debt safely.

But the other side of the story is that Topchoice Medical saw its EBIT decline by 4.8% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Topchoice Medical 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, a company can only pay off debt with cold hard cash, not accounting profits. Topchoice Medical 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. Looking at the most recent three years, Topchoice Medical recorded free cash flow of 45% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

We could understand if investors are concerned about Topchoice Medical's liabilities, but we can be reassured by the fact it has has net cash of CN¥139.3m. So we don't have any problem with Topchoice Medical's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. We've identified 1 warning sign with Topchoice Medical , and understanding them should be part of your investment process.

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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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@simplywallst.com