Xiangyu MedicalLtd (SHSE:688626) Seems To Use Debt Quite Sensibly

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 Xiangyu Medical Co.,Ltd (SHSE:688626) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

Check out our latest analysis for Xiangyu MedicalLtd

What Is Xiangyu MedicalLtd's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Xiangyu MedicalLtd had CN¥287.0m of debt, an increase on CN¥72.2m, over one year. But on the other hand it also has CN¥926.9m in cash, leading to a CN¥639.9m net cash position.

How Strong Is Xiangyu MedicalLtd's Balance Sheet?

According to the last reported balance sheet, Xiangyu MedicalLtd had liabilities of CN¥559.8m due within 12 months, and liabilities of CN¥112.9m due beyond 12 months. Offsetting this, it had CN¥926.9m in cash and CN¥71.4m in receivables that were due within 12 months. So it can boast CN¥325.6m more liquid assets than total liabilities.

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

Even more impressive was the fact that Xiangyu MedicalLtd grew its EBIT by 126% over twelve months. That boost will make it even easier to pay down debt going forward. 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 Xiangyu MedicalLtd 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. Xiangyu MedicalLtd 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. During the last three years, Xiangyu MedicalLtd burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Xiangyu MedicalLtd has net cash of CN¥639.9m, as well as more liquid assets than liabilities. And we liked the look of last year's 126% year-on-year EBIT growth. So is Xiangyu MedicalLtd's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 2 warning signs for Xiangyu MedicalLtd (1 is concerning!) that you should be aware of before investing here.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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