MedCap (STO:MCAP) Seems To Use Debt Rather Sparingly

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.' 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. As with many other companies MedCap AB (publ) (STO:MCAP) makes use of debt. 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. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for MedCap

What Is MedCap's Net Debt?

As you can see below, MedCap had kr87.0m of debt at September 2021, down from kr134.5m a year prior. However, its balance sheet shows it holds kr132.5m in cash, so it actually has kr45.5m net cash.

A Look At MedCap's Liabilities

Zooming in on the latest balance sheet data, we can see that MedCap had liabilities of kr244.9m due within 12 months and liabilities of kr242.7m due beyond that. Offsetting this, it had kr132.5m in cash and kr165.3m in receivables that were due within 12 months. So its liabilities total kr189.8m more than the combination of its cash and short-term receivables.

Given MedCap has a market capitalization of kr2.42b, 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.

In addition to that, we're happy to report that MedCap has boosted its EBIT by 42%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But it is MedCap's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. MedCap may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, MedCap generated free cash flow amounting to a very robust 98% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing up

We could understand if investors are concerned about MedCap's liabilities, but we can be reassured by the fact it has has net cash of kr45.5m. And it impressed us with free cash flow of kr78m, being 98% of its EBIT. So we don't think MedCap's use of debt is risky. We'd be very excited to see if MedCap 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.

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.