Does MedCap (STO:MCAP) Have A Healthy Balance Sheet?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. We note that MedCap AB (publ) (STO:MCAP) does have debt on its balance sheet. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

See our latest analysis for MedCap

What Is MedCap's Debt?

The image below, which you can click on for greater detail, shows that MedCap had debt of kr110.3m at the end of March 2021, a reduction from kr229.6m over a year. But on the other hand it also has kr142.3m in cash, leading to a kr32.0m net cash position.

A Look At MedCap's Liabilities

According to the last reported balance sheet, MedCap had liabilities of kr268.5m due within 12 months, and liabilities of kr230.7m due beyond 12 months. Offsetting this, it had kr142.3m in cash and kr157.3m in receivables that were due within 12 months. So its liabilities total kr199.6m more than the combination of its cash and short-term receivables.

Given MedCap has a market capitalization of kr3.06b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, MedCap also has more cash than debt, so we're pretty confident it can manage its debt safely.

Also positive, MedCap grew its EBIT by 22% in the last year, and that should make it easier to pay down debt, going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine MedCap's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While MedCap 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, MedCap recorded free cash flow worth a fulsome 91% 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 look at a company's total liabilities, it is very reassuring that MedCap has kr32.0m in net cash. And it impressed us with free cash flow of kr80m, being 91% of its EBIT. So we don't think MedCap's use of debt is risky. Over time, share prices tend to follow earnings per share, so if you're interested in MedCap, you may well want to click here to check an interactive graph of its earnings per share history.

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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