Here's Why Dian Diagnostics GroupLtd (SZSE:300244) Can Manage Its Debt Responsibly

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Dian Diagnostics Group Co.,Ltd. (SZSE:300244) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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 Dian Diagnostics GroupLtd

What Is Dian Diagnostics GroupLtd's Net Debt?

The image below, which you can click on for greater detail, shows that Dian Diagnostics GroupLtd had debt of CN¥3.78b at the end of September 2024, a reduction from CN¥4.12b over a year. However, it also had CN¥1.73b in cash, and so its net debt is CN¥2.05b.

How Healthy Is Dian Diagnostics GroupLtd's Balance Sheet?

We can see from the most recent balance sheet that Dian Diagnostics GroupLtd had liabilities of CN¥4.90b falling due within a year, and liabilities of CN¥2.70b due beyond that. Offsetting this, it had CN¥1.73b in cash and CN¥8.67b in receivables that were due within 12 months. So it actually has CN¥2.80b more liquid assets than total liabilities.

This surplus liquidity suggests that Dian Diagnostics GroupLtd's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. On this view, lenders should feel as safe as the beloved of a black-belt karate master.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

While Dian Diagnostics GroupLtd's debt to EBITDA ratio (2.8) suggests that it uses some debt, its interest cover is very weak, at 2.4, suggesting high leverage. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. Even worse, Dian Diagnostics GroupLtd saw its EBIT tank 67% over the last 12 months. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. 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 Dian Diagnostics GroupLtd 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. Looking at the most recent three years, Dian Diagnostics GroupLtd recorded free cash flow of 42% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

Based on what we've seen Dian Diagnostics GroupLtd is not finding it easy, given its EBIT growth rate, but the other factors we considered give us cause to be optimistic. There's no doubt that its ability to to handle its total liabilities is pretty flash. It's also worth noting that Dian Diagnostics GroupLtd is in the Healthcare industry, which is often considered to be quite defensive. When we consider all the factors mentioned above, we do feel a bit cautious about Dian Diagnostics GroupLtd's use of debt. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 1 warning sign with Dian Diagnostics GroupLtd , and understanding them should be part of your investment process.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.