We Think Gaush Meditech (HKG:2407) Can Stay On Top Of Its Debt

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.' 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, Gaush Meditech Ltd (HKG:2407) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Gaush Meditech

What Is Gaush Meditech's Debt?

The image below, which you can click on for greater detail, shows that Gaush Meditech had debt of CN¥618.6m at the end of December 2023, a reduction from CN¥701.6m over a year. However, it does have CN¥833.0m in cash offsetting this, leading to net cash of CN¥214.5m.

A Look At Gaush Meditech's Liabilities

The latest balance sheet data shows that Gaush Meditech had liabilities of CN¥891.7m due within a year, and liabilities of CN¥255.1m falling due after that. Offsetting this, it had CN¥833.0m in cash and CN¥149.1m in receivables that were due within 12 months. So it has liabilities totalling CN¥164.6m more than its cash and near-term receivables, combined.

Given Gaush Meditech has a market capitalization of CN¥2.24b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Gaush Meditech also has more cash than debt, so we're pretty confident it can manage its debt safely.

One way Gaush Meditech could vanquish its debt would be if it stops borrowing more but continues to grow EBIT at around 12%, as it did over the last year. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Gaush Meditech 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Gaush Meditech 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. Over the most recent three years, Gaush Meditech recorded free cash flow worth 73% 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.

Summing Up

We could understand if investors are concerned about Gaush Meditech's liabilities, but we can be reassured by the fact it has has net cash of CN¥214.5m. And it impressed us with free cash flow of CN¥203m, being 73% of its EBIT. So is Gaush Meditech's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Gaush Meditech you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.