Is Venus Medtech (Hangzhou) (HKG:2500) Weighed On By Its Debt Load?

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Venus Medtech (Hangzhou) Inc. (HKG:2500) does carry debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. 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.

Our analysis indicates that 2500 is potentially overvalued!

How Much Debt Does Venus Medtech (Hangzhou) Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2022 Venus Medtech (Hangzhou) had CN¥924.7m of debt, an increase on none, over one year. But on the other hand it also has CN¥2.44b in cash, leading to a CN¥1.51b net cash position.

How Healthy Is Venus Medtech (Hangzhou)'s Balance Sheet?

The latest balance sheet data shows that Venus Medtech (Hangzhou) had liabilities of CN¥754.0m due within a year, and liabilities of CN¥1.11b falling due after that. Offsetting this, it had CN¥2.44b in cash and CN¥336.3m in receivables that were due within 12 months. So it actually has CN¥905.6m more liquid assets than total liabilities.

This surplus suggests that Venus Medtech (Hangzhou) is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that Venus Medtech (Hangzhou) has more cash than debt is arguably a good indication that it can manage its debt safely. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Venus Medtech (Hangzhou) can strengthen its balance sheet over time. 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 Venus Medtech (Hangzhou) had a loss before interest and tax, and actually shrunk its revenue by 6.5%, to CN¥387m. We would much prefer see growth.

So How Risky Is Venus Medtech (Hangzhou)?

We have no doubt that loss making companies are, in general, riskier than profitable ones. And we do note that Venus Medtech (Hangzhou) had an earnings before interest and tax (EBIT) loss, over the last year. And over the same period it saw negative free cash outflow of CN¥781m and booked a CN¥461m accounting loss. While this does make the company a bit risky, it's important to remember it has net cash of CN¥1.51b. That kitty means the company can keep spending for growth for at least two years, at current rates. Overall, its balance sheet doesn't seem overly risky, at the moment, but we're always cautious until we see the positive free cash flow. 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. For example - Venus Medtech (Hangzhou) has 1 warning sign we think you should be aware of.

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.