Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. As with many other companies IVD Medical Holding Limited (HKG:1931) makes use of debt. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.
How Much Debt Does IVD Medical Holding Carry?
The image below, which you can click on for greater detail, shows that at June 2019 IVD Medical Holding had debt of CN¥110.0m, up from CN¥320.0k in one year. However, it does have CN¥419.0m in cash offsetting this, leading to net cash of CN¥309.0m.
A Look At IVD Medical Holding's Liabilities
According to the last reported balance sheet, IVD Medical Holding had liabilities of CN¥1.05b due within 12 months, and liabilities of CN¥202.5m due beyond 12 months. Offsetting this, it had CN¥419.0m in cash and CN¥270.5m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥566.9m.
Of course, IVD Medical Holding has a market capitalization of CN¥3.64b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, IVD Medical Holding boasts net cash, so it's fair to say it does not have a heavy debt load!
Even more impressive was the fact that IVD Medical Holding grew its EBIT by 231% over twelve months. That boost will make it even easier to pay down debt going forward. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since IVD Medical Holding 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.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. IVD Medical Holding 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. Considering the last three years, IVD Medical Holding actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.
While IVD Medical Holding does have more liabilities than liquid assets, it also has net cash of CN¥309.0m. And we liked the look of last year's 231% year-on-year EBIT growth. So we don't have any problem with IVD Medical Holding's use of debt. Over time, share prices tend to follow earnings per share, so if you're interested in IVD Medical Holding, you may well want to click here to check an interactive graph of its earnings per share history.
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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