Lepu Medical Technology (Beijing) (SZSE:300003) Has A Pretty Healthy Balance Sheet

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. We can see that Lepu Medical Technology (Beijing) Co., Ltd. (SZSE:300003) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Lepu Medical Technology (Beijing)

What Is Lepu Medical Technology (Beijing)'s Debt?

As you can see below, at the end of September 2024, Lepu Medical Technology (Beijing) had CN¥5.52b of debt, up from CN¥4.58b a year ago. Click the image for more detail. However, it also had CN¥3.75b in cash, and so its net debt is CN¥1.76b.

How Healthy Is Lepu Medical Technology (Beijing)'s Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Lepu Medical Technology (Beijing) had liabilities of CN¥2.63b due within 12 months and liabilities of CN¥5.08b due beyond that. Offsetting this, it had CN¥3.75b in cash and CN¥2.25b in receivables that were due within 12 months. So its liabilities total CN¥1.70b more than the combination of its cash and short-term receivables.

Since publicly traded Lepu Medical Technology (Beijing) shares are worth a total of CN¥21.9b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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).

Lepu Medical Technology (Beijing)'s net debt is only 1.2 times its EBITDA. And its EBIT easily covers its interest expense, being 15.0 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. It is just as well that Lepu Medical Technology (Beijing)'s load is not too heavy, because its EBIT was down 55% 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 ultimately the future profitability of the business will decide if Lepu Medical Technology (Beijing) 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, Lepu Medical Technology (Beijing)'s free cash flow amounted to 47% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

Based on what we've seen Lepu Medical Technology (Beijing) is not finding it easy, given its EBIT growth rate, but the other factors we considered give us cause to be optimistic. In particular, we are dazzled with its interest cover. It's also worth noting that Lepu Medical Technology (Beijing) is in the Medical Equipment industry, which is often considered to be quite defensive. Looking at all this data makes us feel a little cautious about Lepu Medical Technology (Beijing)'s debt levels. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. 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 example Lepu Medical Technology (Beijing) has 2 warning signs (and 1 which is potentially serious) we think you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.