MedCap (STO:MCAP) Could Easily Take On More Debt

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 can see that MedCap AB (publ) (STO:MCAP) does use debt in its business. But the real question is whether this debt is making the company risky.

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for MedCap

How Much Debt Does MedCap Carry?

The chart below, which you can click on for greater detail, shows that MedCap had kr134.5m in debt in September 2020; about the same as the year before. However, it does have kr171.4m in cash offsetting this, leading to net cash of kr36.9m.

A Look At MedCap's Liabilities

Zooming in on the latest balance sheet data, we can see that MedCap had liabilities of kr246.7m due within 12 months and liabilities of kr203.7m due beyond that. Offsetting these obligations, it had cash of kr171.4m as well as receivables valued at kr142.4m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by kr136.6m.

Since publicly traded MedCap shares are worth a total of kr2.98b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, MedCap boasts net cash, so it's fair to say it does not have a heavy debt load!

The good news is that MedCap has increased its EBIT by 6.4% 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 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. 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. During the last three years, MedCap generated free cash flow amounting to a very robust 86% of its EBIT, more than we'd 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 kr36.9m in net cash. The cherry on top was that in converted 86% of that EBIT to free cash flow, bringing in kr64m. So is MedCap's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 1 warning sign with MedCap , and understanding them should be part of your investment process.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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This article by Simply Wall St is general in nature. 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.
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