These 4 Measures Indicate That Chengdu Bright Eye Hospital Group (SZSE:301239) Is Using Debt Extensively

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Chengdu Bright Eye Hospital Group Co., Ltd. (SZSE:301239) 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Chengdu Bright Eye Hospital Group

What Is Chengdu Bright Eye Hospital Group's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2024 Chengdu Bright Eye Hospital Group had debt of CN¥595.3m, up from CN¥490.7m in one year. But it also has CN¥635.9m in cash to offset that, meaning it has CN¥40.6m net cash.

How Healthy Is Chengdu Bright Eye Hospital Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Chengdu Bright Eye Hospital Group had liabilities of CN¥785.2m due within 12 months and liabilities of CN¥1.67b due beyond that. On the other hand, it had cash of CN¥635.9m and CN¥196.0m worth of receivables due within a year. So its liabilities total CN¥1.62b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Chengdu Bright Eye Hospital Group is worth CN¥7.79b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, Chengdu Bright Eye Hospital Group boasts net cash, so it's fair to say it does not have a heavy debt load!

Importantly, Chengdu Bright Eye Hospital Group's EBIT fell a jaw-dropping 54% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Chengdu Bright Eye Hospital Group's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Chengdu Bright Eye Hospital Group 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. Over the last three years, Chengdu Bright Eye Hospital Group recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Summing Up

Although Chengdu Bright Eye Hospital Group's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥40.6m. Despite the cash, we do find Chengdu Bright Eye Hospital Group's EBIT growth rate concerning, so we're not particularly comfortable with the stock. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Be aware that Chengdu Bright Eye Hospital Group is showing 2 warning signs in our investment analysis , you should know about...

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.