Does China Medical System Holdings (HKG:867) Have A Healthy Balance Sheet?

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.' 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. We can see that China Medical System Holdings Limited (HKG:867) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for China Medical System Holdings

What Is China Medical System Holdings's Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2021 China Medical System Holdings had CN¥1.09b of debt, an increase on CN¥694.0m, over one year. However, it does have CN¥3.29b in cash offsetting this, leading to net cash of CN¥2.20b.

A Look At China Medical System Holdings' Liabilities

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 can boast CN¥2.95b more liquid assets than total liabilities.

This surplus suggests that China Medical System Holdings has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, China Medical System Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

Another good sign is that China Medical System Holdings has been able to increase its EBIT by 24% in twelve months, making it easier to pay down debt. There's no doubt that we learn most about debt from the balance sheet. 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 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 is China Medical System Holdings's debt a risk? It doesn't seem so to us. We'd be very excited to see if China Medical System Holdings insiders have been snapping up shares. If you are too, then click on this link right now to take a (free) peek at our list of reported insider transactions.

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.

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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.