Is Guangzhou Kingmed Diagnostics Group (SHSE:603882) Using Too Much Debt?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Guangzhou Kingmed Diagnostics Group Co., Ltd. (SHSE:603882) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Guangzhou Kingmed Diagnostics Group

What Is Guangzhou Kingmed Diagnostics Group's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2024 Guangzhou Kingmed Diagnostics Group had debt of CN¥444.5m, up from CN¥380.4m in one year. However, its balance sheet shows it holds CN¥2.11b in cash, so it actually has CN¥1.66b net cash.

How Healthy Is Guangzhou Kingmed Diagnostics Group's Balance Sheet?

According to the last reported balance sheet, Guangzhou Kingmed Diagnostics Group had liabilities of CN¥2.65b due within 12 months, and liabilities of CN¥566.8m due beyond 12 months. Offsetting this, it had CN¥2.11b in cash and CN¥5.63b in receivables that were due within 12 months. So it actually has CN¥4.52b more liquid assets than total liabilities.

This excess liquidity is a great indication that Guangzhou Kingmed Diagnostics Group's balance sheet is almost as strong as Fort Knox. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Succinctly put, Guangzhou Kingmed Diagnostics Group boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that Guangzhou Kingmed Diagnostics Group's load is not too heavy, because its EBIT was down 91% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. 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 Guangzhou Kingmed Diagnostics Group'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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Guangzhou Kingmed Diagnostics Group has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. In the last three years, Guangzhou Kingmed Diagnostics Group's free cash flow amounted to 44% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While it is always sensible to investigate a company's debt, in this case Guangzhou Kingmed Diagnostics Group has CN¥1.66b in net cash and a decent-looking balance sheet. So we don't have any problem with Guangzhou Kingmed Diagnostics Group's use of debt. 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. We've identified 2 warning signs with Guangzhou Kingmed Diagnostics Group , 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.