Is Yonghe Medical Group (HKG:2279) Using Debt Sensibly?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 Yonghe Medical Group Co., Ltd. (HKG:2279) makes use of debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. 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 Yonghe Medical Group

What Is Yonghe Medical Group's Net Debt?

As you can see below, at the end of December 2023, Yonghe Medical Group had CN¥152.8m of debt, up from none a year ago. Click the image for more detail. But it also has CN¥673.1m in cash to offset that, meaning it has CN¥520.3m net cash.

A Look At Yonghe Medical Group's Liabilities

According to the last reported balance sheet, Yonghe Medical Group had liabilities of CN¥722.9m due within 12 months, and liabilities of CN¥779.4m due beyond 12 months. Offsetting these obligations, it had cash of CN¥673.1m as well as receivables valued at CN¥14.4m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥814.8m.

The deficiency here weighs heavily on the CN¥501.3m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, Yonghe Medical Group would likely require a major re-capitalisation if it had to pay its creditors today. Given that Yonghe Medical Group has more cash than debt, we're pretty confident it can handle its debt, despite the fact that it has a lot of liabilities in total. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Yonghe Medical Group's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

In the last year Yonghe Medical Group wasn't profitable at an EBIT level, but managed to grow its revenue by 26%, to CN¥1.8b. Shareholders probably have their fingers crossed that it can grow its way to profits.

So How Risky Is Yonghe Medical Group?

By their very nature companies that are losing money are more risky than those with a long history of profitability. And the fact is that over the last twelve months Yonghe Medical Group lost money at the earnings before interest and tax (EBIT) line. Indeed, in that time it burnt through CN¥188m of cash and made a loss of CN¥538m. But the saving grace is the CN¥520.3m on the balance sheet. That means it could keep spending at its current rate for more than two years. Yonghe Medical Group's revenue growth shone bright over the last year, so it may well be in a position to turn a profit in due course. Pre-profit companies are often risky, but they can also offer great rewards. 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. Be aware that Yonghe Medical Group is showing 2 warning signs in our investment analysis , you should know about...

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.