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

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, China Medical System Holdings Limited (HKG:867) does carry debt. But should shareholders be worried about its use of debt?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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.

Check out our latest analysis for China Medical System Holdings

How Much Debt Does China Medical System Holdings Carry?

You can click the graphic below for the historical numbers, but it shows that China Medical System Holdings had CN¥1.28b of debt in June 2023, down from CN¥1.77b, one year before. But it also has CN¥6.08b in cash to offset that, meaning it has CN¥4.80b net cash.

A Look At China Medical System Holdings' Liabilities

Zooming in on the latest balance sheet data, we can see that China Medical System Holdings had liabilities of CN¥2.22b due within 12 months and liabilities of CN¥134.2m due beyond that. Offsetting this, it had CN¥6.08b in cash and CN¥2.52b in receivables that were due within 12 months. So it can boast CN¥6.24b more liquid assets than total liabilities.

This surplus suggests that China Medical System Holdings is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Succinctly put, China Medical System Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

Fortunately, China Medical System Holdings grew its EBIT by 7.9% in the last year, making that debt load look even more manageable. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if China Medical System Holdings can strengthen its balance sheet over time. 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. China Medical System Holdings may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the most recent three years, China Medical System Holdings recorded free cash flow worth 78% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that China Medical System Holdings has net cash of CN¥4.80b, as well as more liquid assets than liabilities. The cherry on top was that in converted 78% of that EBIT to free cash flow, bringing in CN¥3.0b. So we don't think China Medical System Holdings's use of debt is risky. Given China Medical System Holdings has a strong balance sheet is profitable and pays a dividend, it would be good to know how fast its dividends are growing, if at all. You can find out instantly by clicking this link.

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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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.