Kingworld Medicines Group (HKG:1110) Seems To Use Debt Rather Sparingly

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. As with many other companies Kingworld Medicines Group Limited (HKG:1110) makes use of debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Kingworld Medicines Group

How Much Debt Does Kingworld Medicines Group Carry?

The image below, which you can click on for greater detail, shows that at December 2020 Kingworld Medicines Group had debt of CN¥296.5m, up from CN¥214.3m in one year. However, it also had CN¥261.5m in cash, and so its net debt is CN¥35.1m.

A Look At Kingworld Medicines Group's Liabilities

Zooming in on the latest balance sheet data, we can see that Kingworld Medicines Group had liabilities of CN¥555.7m due within 12 months and liabilities of CN¥21.2m due beyond that. On the other hand, it had cash of CN¥261.5m and CN¥296.9m worth of receivables due within a year. So it has liabilities totalling CN¥18.5m more than its cash and near-term receivables, combined.

Of course, Kingworld Medicines Group has a market capitalization of CN¥406.5m, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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.

Kingworld Medicines Group has net debt of just 0.37 times EBITDA, suggesting it could ramp leverage without breaking a sweat. And remarkably, despite having net debt, it actually received more in interest over the last twelve months than it had to pay. So it's fair to say it can handle debt like a hotshot teppanyaki chef handles cooking. While Kingworld Medicines Group doesn't seem to have gained much on the EBIT line, at least earnings remain stable for now. When analysing debt levels, the balance sheet is the obvious place to start. But it is Kingworld Medicines Group's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Kingworld Medicines Group recorded free cash flow worth a fulsome 89% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Our View

The good news is that Kingworld Medicines Group's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And the good news does not stop there, as its conversion of EBIT to free cash flow also supports that impression! It's also worth noting that Kingworld Medicines Group is in the Healthcare industry, which is often considered to be quite defensive. Zooming out, Kingworld Medicines Group seems to use debt quite reasonably; and that gets the nod from us. While debt does bring risk, when used wisely it can also bring a higher return on equity. 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 instance, we've identified 4 warning signs for Kingworld Medicines Group (1 is a bit unpleasant) you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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This article by Simply Wall St is general in nature. 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.
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