Is China Resources Medical Holdings (HKG:1515) Using Too Much Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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, China Resources Medical Holdings Company Limited (HKG:1515) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

See our latest analysis for China Resources Medical Holdings

What Is China Resources Medical Holdings's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2023 China Resources Medical Holdings had debt of CN¥2.43b, up from CN¥1.74b in one year. However, it does have CN¥4.39b in cash offsetting this, leading to net cash of CN¥1.96b.

How Strong Is China Resources Medical Holdings' Balance Sheet?

According to the last reported balance sheet, China Resources Medical Holdings had liabilities of CN¥9.56b due within 12 months, and liabilities of CN¥1.76b due beyond 12 months. Offsetting this, it had CN¥4.39b in cash and CN¥2.62b in receivables that were due within 12 months. So it has liabilities totalling CN¥4.32b more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of CN¥5.35b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. While it does have liabilities worth noting, China Resources Medical Holdings also has more cash than debt, so we're pretty confident it can manage its debt safely.

In addition to that, we're happy to report that China Resources Medical Holdings has boosted its EBIT by 41%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if China Resources Medical Holdings 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. While China Resources Medical Holdings 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. Over the last three years, China Resources Medical Holdings actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While China Resources Medical Holdings does have more liabilities than liquid assets, it also has net cash of CN¥1.96b. And it impressed us with free cash flow of CN¥733m, being 101% of its EBIT. So we don't think China Resources Medical Holdings's use of debt is risky. 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 example - China Resources Medical Holdings has 1 warning sign we think 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. 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.