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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Modern Dental Group Limited (HKG:3600) does carry debt. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
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. 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 step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does Modern Dental Group Carry?
You can click the graphic below for the historical numbers, but it shows that Modern Dental Group had HK$717.7m of debt in June 2021, down from HK$823.3m, one year before. However, it also had HK$693.8m in cash, and so its net debt is HK$23.9m.
How Healthy Is Modern Dental Group's Balance Sheet?
According to the last reported balance sheet, Modern Dental Group had liabilities of HK$675.5m due within 12 months, and liabilities of HK$646.8m due beyond 12 months. Offsetting this, it had HK$693.8m in cash and HK$563.6m in receivables that were due within 12 months. So it has liabilities totalling HK$65.0m more than its cash and near-term receivables, combined.
This state of affairs indicates that Modern Dental Group's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the HK$6.66b company is short on cash, but still worth keeping an eye on the balance sheet. Carrying virtually no net debt, Modern Dental Group has a very light debt load indeed.
In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Modern Dental Group has very little debt (net of cash), and boasts a debt to EBITDA ratio of 0.039 and EBIT of 24.3 times the interest expense. So relative to past earnings, the debt load seems trivial. Even more impressive was the fact that Modern Dental Group grew its EBIT by 238% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. 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 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Modern Dental Group recorded free cash flow worth a fulsome 98% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.
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. And that's just the beginning of the good news since its conversion of EBIT to free cash flow is also very heartening. We would also note that Medical Equipment industry companies like Modern Dental Group commonly do use debt without problems. It looks Modern Dental Group has no trouble standing on its own two feet, and it has no reason to fear its lenders. For investing nerds like us its balance sheet is almost charming. 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. We've identified 1 warning sign with Modern Dental Group , and understanding them should be part of your investment process.
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.
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.
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