Is Aidigong Maternal & Child Health (HKG:286) Using Debt In A Risky Way?

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, Aidigong Maternal & Child Health Limited (HKG:286) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. When we think about a company's use of debt, we first look at cash and debt together.

Check out the opportunities and risks within the HK Healthcare industry.

How Much Debt Does Aidigong Maternal & Child Health Carry?

As you can see below, at the end of June 2022, Aidigong Maternal & Child Health had HK$955.2m of debt, up from HK$876.4m a year ago. Click the image for more detail. However, it also had HK$180.3m in cash, and so its net debt is HK$774.9m.

A Look At Aidigong Maternal & Child Health's Liabilities

We can see from the most recent balance sheet that Aidigong Maternal & Child Health had liabilities of HK$693.7m falling due within a year, and liabilities of HK$1.37b due beyond that. Offsetting this, it had HK$180.3m in cash and HK$271.3m in receivables that were due within 12 months. So its liabilities total HK$1.61b more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of HK$1.67b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Aidigong Maternal & Child Health's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Over 12 months, Aidigong Maternal & Child Health reported revenue of HK$647m, which is a gain of 7.7%, although it did not report any earnings before interest and tax. That rate of growth is a bit slow for our taste, but it takes all types to make a world.

Caveat Emptor

Over the last twelve months Aidigong Maternal & Child Health produced an earnings before interest and tax (EBIT) loss. To be specific the EBIT loss came in at HK$35m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. We would feel better if it turned its trailing twelve month loss of HK$80m into a profit. So we do think this stock is quite risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Be aware that Aidigong Maternal & Child Health is showing 1 warning sign 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.