Lepu Medical Technology (Beijing) (SZSE:300003) Seems To Use Debt Quite Sensibly

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Lepu Medical Technology (Beijing) Co., Ltd. (SZSE:300003) does use debt in its business. But the more important question is: how much risk is that debt creating?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth 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.

See our latest analysis for Lepu Medical Technology (Beijing)

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

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Lepu Medical Technology (Beijing) had CN¥4.78b of debt, an increase on CN¥4.47b, over one year. However, it also had CN¥4.40b in cash, and so its net debt is CN¥381.2m.

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

We can see from the most recent balance sheet that Lepu Medical Technology (Beijing) had liabilities of CN¥3.67b falling due within a year, and liabilities of CN¥3.83b due beyond that. Offsetting this, it had CN¥4.40b in cash and CN¥2.43b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥668.5m.

Since publicly traded Lepu Medical Technology (Beijing) shares are worth a total of CN¥30.6b, 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. Carrying virtually no net debt, Lepu Medical Technology (Beijing) has a very light debt load indeed.

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.

Lepu Medical Technology (Beijing) has a low net debt to EBITDA ratio of only 0.19. And its EBIT covers its interest expense a whopping 24.5 times over. So we're pretty relaxed about its super-conservative use of debt. It is just as well that Lepu Medical Technology (Beijing)'s load is not too heavy, because its EBIT was down 48% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. There's no doubt that we learn most about debt from the balance sheet. 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, Lepu Medical Technology (Beijing)'s free cash flow amounted to 46% 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. Considering this range of data points, we think Lepu Medical Technology (Beijing) is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Lepu Medical Technology (Beijing) you should know about.

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.