China Resources Medical Holdings (HKG:1515) Has A Pretty Healthy Balance Sheet

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, China Resources Medical Holdings Company Limited (HKG:1515) does carry debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for China Resources Medical Holdings

What Is China Resources Medical Holdings's Debt?

The image below, which you can click on for greater detail, shows that at December 2023 China Resources Medical Holdings had debt of CN¥2.16b, up from CN¥2.02b in one year. However, it also had CN¥1.24b in cash, and so its net debt is CN¥926.6m.

How Strong Is China Resources Medical Holdings' Balance Sheet?

We can see from the most recent balance sheet that China Resources Medical Holdings had liabilities of CN¥5.21b falling due within a year, and liabilities of CN¥1.43b due beyond that. Offsetting this, it had CN¥1.24b in cash and CN¥1.58b in receivables that were due within 12 months. So it has liabilities totalling CN¥3.83b more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of CN¥4.96b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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.

China Resources Medical Holdings has a low net debt to EBITDA ratio of only 0.85. And its EBIT easily covers its interest expense, being 18.8 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Better yet, China Resources Medical Holdings grew its EBIT by 182% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine China Resources Medical Holdings'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 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 most recent three years, China Resources Medical Holdings recorded free cash flow worth 61% 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.

Our View

Happily, China Resources Medical Holdings's impressive interest cover implies it has the upper hand on its debt. But, on a more sombre note, we are a little concerned by its level of total liabilities. It's also worth noting that China Resources Medical Holdings is in the Healthcare industry, which is often considered to be quite defensive. Taking all this data into account, it seems to us that China Resources Medical Holdings takes a pretty sensible approach to debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. 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. To that end, you should be aware of the 1 warning sign we've spotted with China Resources Medical Holdings .

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.