China Medical System Holdings (HKG:867) Could Easily Take On More Debt

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 System Holdings Limited (HKG:867) makes use of debt. But the real question is whether this debt is making the company risky.

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for China Medical System Holdings

How Much Debt Does China Medical System Holdings Carry?

The image below, which you can click on for greater detail, shows that at June 2021 China Medical System Holdings had debt of CN¥1.09b, up from CN¥694.0m in one year. However, it does have CN¥3.29b in cash offsetting this, leading to net cash of CN¥2.20b.

How Strong Is China Medical System Holdings' Balance Sheet?

The latest balance sheet data shows that China Medical System Holdings had liabilities of CN¥1.40b due within a year, and liabilities of CN¥850.5m falling due after that. On the other hand, it had cash of CN¥3.29b and CN¥1.92b worth of receivables due within a year. So it actually has CN¥2.95b more liquid assets than total liabilities.

This short term liquidity is a sign that China Medical System Holdings could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, China Medical System Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

Also positive, China Medical System Holdings grew its EBIT by 24% in the last year, and that should make it easier to pay down debt, going forward. 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 China Medical System Holdings's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While China Medical System Holdings has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, China Medical System Holdings recorded free cash flow worth a fulsome 86% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Summing up

While it is always sensible to investigate a company's debt, in this case China Medical System Holdings has CN¥2.20b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 86% of that EBIT to free cash flow, bringing in CN¥2.4b. So we don't think China Medical System Holdings's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Be aware that China Medical System Holdings is showing 1 warning sign in our investment analysis , 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.
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