These 4 Measures Indicate That United Laboratories International Holdings (HKG:3933) Is Using Debt Safely

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.' 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, The United Laboratories International Holdings Limited (HKG:3933) does carry debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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.

Check out our latest analysis for United Laboratories International Holdings

What Is United Laboratories International Holdings's Debt?

As you can see below, United Laboratories International Holdings had CN¥3.26b of debt at June 2020, down from CN¥4.43b a year prior. On the flip side, it has CN¥3.08b in cash leading to net debt of about CN¥186.9m.

A Look At United Laboratories International Holdings's Liabilities

Zooming in on the latest balance sheet data, we can see that United Laboratories International Holdings had liabilities of CN¥4.70b due within 12 months and liabilities of CN¥2.59b due beyond that. Offsetting these obligations, it had cash of CN¥3.08b as well as receivables valued at CN¥3.11b due within 12 months. So its liabilities total CN¥1.11b more than the combination of its cash and short-term receivables.

Given United Laboratories International Holdings has a market capitalization of CN¥9.14b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Looking at its net debt to EBITDA of 0.11 and interest cover of 6.3 times, it seems to us that United Laboratories International Holdings is probably using debt in a pretty reasonable way. So we'd recommend keeping a close eye on the impact financing costs are having on the business. On top of that, United Laboratories International Holdings grew its EBIT by 45% over the last twelve months, and that growth will make it easier to handle its debt. 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 United Laboratories International Holdings'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 always check how much of that EBIT is translated into free cash flow. Over the last three years, United Laboratories International Holdings recorded free cash flow worth a fulsome 98% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Our View

Happily, United Laboratories International Holdings's impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. And the good news does not stop there, as its EBIT growth rate also supports that impression! Overall, we don't think United Laboratories International Holdings is taking any bad risks, as its debt load seems modest. So we're not worried about the use of a little leverage on the balance sheet. 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, we've discovered 5 warning signs for United Laboratories International Holdings that you should be aware of before investing here.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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