Here's Why Modern Dental Group (HKG:3600) Can Manage Its Debt Responsibly

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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, Modern Dental Group Limited (HKG:3600) does carry debt. But is this debt a concern to shareholders?

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. 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. 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.

See our latest analysis for Modern Dental Group

How Much Debt Does Modern Dental Group Carry?

As you can see below, Modern Dental Group had HK$630.2m of debt at December 2022, down from HK$673.1m a year prior. However, because it has a cash reserve of HK$444.4m, its net debt is less, at about HK$185.8m.

How Healthy Is Modern Dental Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Modern Dental Group had liabilities of HK$529.4m due within 12 months and liabilities of HK$676.1m due beyond that. On the other hand, it had cash of HK$444.4m and HK$578.5m worth of receivables due within a year. So it has liabilities totalling HK$182.6m more than its cash and near-term receivables, combined.

Given Modern Dental Group has a market capitalization of HK$2.48b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Modern Dental Group's net debt is only 0.47 times its EBITDA. And its EBIT covers its interest expense a whopping 13.2 times over. So we're pretty relaxed about its super-conservative use of debt. It is just as well that Modern Dental Group's load is not too heavy, because its EBIT was down 38% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Modern Dental Group'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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Modern Dental Group produced sturdy free cash flow equating to 67% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

The good news is that Modern Dental Group's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But we must concede we find its EBIT growth rate has the opposite effect. It's also worth noting that Modern Dental Group is in the Medical Equipment industry, which is often considered to be quite defensive. Looking at all the aforementioned factors together, it strikes us that Modern Dental Group can handle its debt fairly comfortably. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Modern Dental Group 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.