Allmed Medical ProductsLtd (SZSE:002950) Has A Pretty Healthy Balance Sheet

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.' 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 can see that Allmed Medical Products Co.,Ltd (SZSE:002950) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Allmed Medical ProductsLtd

How Much Debt Does Allmed Medical ProductsLtd Carry?

The image below, which you can click on for greater detail, shows that Allmed Medical ProductsLtd had debt of CN¥668.6m at the end of September 2023, a reduction from CN¥1.19b over a year. However, it also had CN¥512.5m in cash, and so its net debt is CN¥156.2m.

How Healthy Is Allmed Medical ProductsLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Allmed Medical ProductsLtd had liabilities of CN¥1.34b due within 12 months and liabilities of CN¥603.4m due beyond that. On the other hand, it had cash of CN¥512.5m and CN¥388.1m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥1.04b.

Allmed Medical ProductsLtd has a market capitalization of CN¥4.97b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Allmed Medical ProductsLtd's net debt is only 0.24 times its EBITDA. And its EBIT easily covers its interest expense, being 18.0 times the size. So we're pretty relaxed about its super-conservative use of debt. The modesty of its debt load may become crucial for Allmed Medical ProductsLtd if management cannot prevent a repeat of the 30% cut to EBIT 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 Allmed Medical ProductsLtd's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Allmed Medical ProductsLtd recorded free cash flow worth a fulsome 84% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Our View

Allmed Medical ProductsLtd's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But we must concede we find its EBIT growth rate has the opposite effect. We would also note that Medical Equipment industry companies like Allmed Medical ProductsLtd commonly do use debt without problems. Looking at all the aforementioned factors together, it strikes us that Allmed Medical ProductsLtd can handle its debt fairly comfortably. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. 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. For instance, we've identified 2 warning signs for Allmed Medical ProductsLtd (1 is significant) you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.