We Think China Medical System Holdings (HKG:867) Can Manage Its Debt With Ease

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that China Medical System Holdings Limited (HKG:867) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. 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, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View 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 December 2022 China Medical System Holdings had debt of CN¥1.78b, up from CN¥1.68b in one year. However, its balance sheet shows it holds CN¥5.88b in cash, so it actually has CN¥4.09b net cash.

How Strong Is China Medical System Holdings' Balance Sheet?

According to the last reported balance sheet, China Medical System Holdings had liabilities of CN¥2.88b due within 12 months, and liabilities of CN¥139.4m due beyond 12 months. Offsetting these obligations, it had cash of CN¥5.88b as well as receivables valued at CN¥2.23b due within 12 months. So it actually has CN¥5.09b more liquid assets than total liabilities.

This excess liquidity suggests that China Medical System Holdings is taking a careful approach to debt. Due to its strong net asset position, it is not likely to face 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!

And we also note warmly that China Medical System Holdings grew its EBIT by 13% last year, making its debt load easier to handle. The balance sheet is clearly the area to focus on when you are analysing debt. 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, a company can only pay off debt with cold hard cash, not accounting profits. 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 81% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case China Medical System Holdings has CN¥4.09b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 81% of that EBIT to free cash flow, bringing in CN¥3.0b. So is China Medical System Holdings's debt a risk? It doesn't seem so to us. Another positive for shareholders is that it pays dividends. So if you like receiving those dividend payments, check China Medical System Holdings's dividend history, without delay!

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.