Is China Medical & HealthCare Group (HKG:383) Using Debt In A Risky Way?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies China Medical & HealthCare Group Limited (HKG:383) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for China Medical & HealthCare Group

What Is China Medical & HealthCare Group's Net Debt?

As you can see below, China Medical & HealthCare Group had HK$907.0m of debt at June 2022, down from HK$971.3m a year prior. However, it does have HK$544.6m in cash offsetting this, leading to net debt of about HK$362.4m.

How Strong Is China Medical & HealthCare Group's Balance Sheet?

We can see from the most recent balance sheet that China Medical & HealthCare Group had liabilities of HK$1.30b falling due within a year, and liabilities of HK$389.2m due beyond that. Offsetting these obligations, it had cash of HK$544.6m as well as receivables valued at HK$164.5m due within 12 months. So it has liabilities totalling HK$980.8m more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of HK$868.8m, we think shareholders really should watch China Medical & HealthCare Group's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since China Medical & HealthCare Group will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, China Medical & HealthCare Group reported revenue of HK$1.5b, which is a gain of 4.3%, although it did not report any earnings before interest and tax. We usually like to see faster growth from unprofitable companies, but each to their own.

Caveat Emptor

Over the last twelve months China Medical & HealthCare Group produced an earnings before interest and tax (EBIT) loss. To be specific the EBIT loss came in at HK$37m. When we look at that alongside the significant liabilities, we're not particularly confident about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. For example, we would not want to see a repeat of last year's loss of HK$107m. And until that time we think this is a risky stock. For riskier companies like China Medical & HealthCare Group I always like to keep an eye on whether insiders are buying or selling. So click here if you want to find out for yourself.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.