Is China Medical System Holdings (HKG:867) A Risky Investment?

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.' 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. 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 and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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 Net Debt?

As you can see below, China Medical System Holdings had CN¥1.28b of debt at June 2023, down from CN¥1.77b a year prior. But it also has CN¥6.08b in cash to offset that, meaning it has CN¥4.80b net cash.

How Healthy Is China Medical System Holdings' Balance Sheet?

According to the last reported balance sheet, China Medical System Holdings had liabilities of CN¥2.22b due within 12 months, and liabilities of CN¥134.2m due beyond 12 months. On the other hand, it had cash of CN¥6.08b and CN¥2.34b worth of receivables due within a year. So it can boast CN¥6.06b more liquid assets than total liabilities.

This excess liquidity suggests that China Medical System Holdings is taking a careful approach to debt. Because it has plenty of assets, it is unlikely to have trouble 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!

The good news is that China Medical System Holdings has increased its EBIT by 7.9% over twelve months, which should ease any concerns about debt repayment. When analysing debt levels, the balance sheet is the obvious place to start. 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. 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. During the last three years, China Medical System Holdings produced sturdy free cash flow equating to 78% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While it is always sensible to investigate a company's debt, in this case China Medical System Holdings has CN¥4.80b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥3.0b, being 78% of its EBIT. So is China Medical System Holdings's debt a risk? It doesn't seem so to us. 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.

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.