Is Shandong Weigao Group Medical Polymer (HKG:1066) Using Too Much Debt?

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.' 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. We note that Shandong Weigao Group Medical Polymer Company Limited (HKG:1066) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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 Shandong Weigao Group Medical Polymer

What Is Shandong Weigao Group Medical Polymer's Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2022 Shandong Weigao Group Medical Polymer had CN¥4.36b of debt, an increase on CN¥4.06b, over one year. But on the other hand it also has CN¥7.36b in cash, leading to a CN¥3.00b net cash position.

How Healthy Is Shandong Weigao Group Medical Polymer's Balance Sheet?

The latest balance sheet data shows that Shandong Weigao Group Medical Polymer had liabilities of CN¥5.93b due within a year, and liabilities of CN¥3.81b falling due after that. On the other hand, it had cash of CN¥7.36b and CN¥7.07b worth of receivables due within a year. So it can boast CN¥4.68b more liquid assets than total liabilities.

This surplus suggests that Shandong Weigao Group Medical Polymer has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Shandong Weigao Group Medical Polymer has more cash than debt is arguably a good indication that it can manage its debt safely.

Shandong Weigao Group Medical Polymer's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Shandong Weigao Group Medical Polymer can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Shandong Weigao Group Medical Polymer 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 most recent three years, Shandong Weigao Group Medical Polymer recorded free cash flow worth 58% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Shandong Weigao Group Medical Polymer has net cash of CN¥3.00b, as well as more liquid assets than liabilities. So we don't think Shandong Weigao Group Medical Polymer's use of debt is risky. We'd be motivated to research the stock further if we found out that Shandong Weigao Group Medical Polymer insiders have bought shares recently. If you would too, then you're in luck, since today we're sharing our list of reported insider transactions for free.

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.