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

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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. We can see that Gaush Meditech Ltd (HKG:2407) does use debt in its business. 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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Gaush Meditech

What Is Gaush Meditech's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Gaush Meditech had CN¥568.2m of debt in June 2024, down from CN¥705.0m, one year before. However, it does have CN¥754.2m in cash offsetting this, leading to net cash of CN¥186.0m.

How Strong Is Gaush Meditech's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Gaush Meditech had liabilities of CN¥740.1m due within 12 months and liabilities of CN¥511.8m due beyond that. On the other hand, it had cash of CN¥754.2m and CN¥145.6m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥352.0m.

While this might seem like a lot, it is not so bad since Gaush Meditech has a market capitalization of CN¥1.44b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, Gaush Meditech boasts net cash, so it's fair to say it does not have a heavy debt load!

Shareholders should be aware that Gaush Meditech's EBIT was down 38% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Gaush Meditech's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

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. During the last three years, Gaush Meditech produced sturdy free cash flow equating to 72% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

Although Gaush Meditech's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥186.0m. And it impressed us with free cash flow of CN¥81m, being 72% of its EBIT. So we don't have any problem with Gaush Meditech's use of debt. 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. Case in point: We've spotted 2 warning signs for Gaush Meditech you should be aware of, and 1 of them makes us a bit uncomfortable.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.