Here's Why PW Medtech Group (HKG:1358) 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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, PW Medtech Group Limited (HKG:1358) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest 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.

Check out our latest analysis for PW Medtech Group

What Is PW Medtech Group's Net Debt?

The image below, which you can click on for greater detail, shows that PW Medtech Group had debt of CN¥9.97m at the end of June 2020, a reduction from CN¥577.6m over a year. However, its balance sheet shows it holds CN¥290.6m in cash, so it actually has CN¥280.6m net cash.

How Strong Is PW Medtech Group's Balance Sheet?

We can see from the most recent balance sheet that PW Medtech Group had liabilities of CN¥142.8m falling due within a year, and liabilities of CN¥20.2m due beyond that. Offsetting these obligations, it had cash of CN¥290.6m as well as receivables valued at CN¥182.5m due within 12 months. So it actually has CN¥310.2m more liquid assets than total liabilities.

This short term liquidity is a sign that PW Medtech Group could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, PW Medtech Group boasts net cash, so it's fair to say it does not have a heavy debt load!

Importantly, PW Medtech Group's EBIT fell a jaw-dropping 87% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since PW Medtech Group will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While PW Medtech Group has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, PW Medtech Group produced sturdy free cash flow equating to 69% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that PW Medtech Group has net cash of CN¥280.6m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥92m, being 69% of its EBIT. So we are not troubled with PW Medtech Group's debt use. 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. Like risks, for instance. Every company has them, and we've spotted 3 warning signs for PW Medtech Group (of which 1 is significant!) 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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