Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that ShareHope Medicine Co., Ltd. (GTSM:8403) does use debt in its business. But is this debt a concern to shareholders?
When Is Debt Dangerous?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is ShareHope Medicine's Debt?
You can click the graphic below for the historical numbers, but it shows that as of September 2020 ShareHope Medicine had NT$596.9m of debt, an increase on NT$510.8m, over one year. But it also has NT$1.57b in cash to offset that, meaning it has NT$975.1m net cash.
A Look At ShareHope Medicine's Liabilities
Zooming in on the latest balance sheet data, we can see that ShareHope Medicine had liabilities of NT$1.63b due within 12 months and liabilities of NT$325.8m due beyond that. Offsetting these obligations, it had cash of NT$1.57b as well as receivables valued at NT$1.09b due within 12 months. So it can boast NT$702.1m more liquid assets than total liabilities.
It's good to see that ShareHope Medicine has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Succinctly put, ShareHope Medicine boasts net cash, so it's fair to say it does not have a heavy debt load!
Better yet, ShareHope Medicine grew its EBIT by 310% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. There's no doubt that we learn most about debt from the balance sheet. But it is ShareHope Medicine'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, a company can only pay off debt with cold hard cash, not accounting profits. ShareHope Medicine 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, ShareHope Medicine produced sturdy free cash flow equating to 78% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
While it is always sensible to investigate a company's debt, in this case ShareHope Medicine has NT$975.1m in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 310% over the last year. The bottom line is that we do not find ShareHope Medicine's debt levels at all concerning. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for ShareHope Medicine you should know about.
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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