We Think Li Kang Biomedical (GTSM:6242) Can Stay On Top Of Its Debt

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Li Kang Biomedical Co., Ltd. (GTSM:6242) 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 assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. 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 Li Kang Biomedical

What Is Li Kang Biomedical's Debt?

As you can see below, Li Kang Biomedical had NT$43.0m of debt at September 2020, down from NT$51.2m a year prior. But on the other hand it also has NT$179.5m in cash, leading to a NT$136.5m net cash position.

How Healthy Is Li Kang Biomedical's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Li Kang Biomedical had liabilities of NT$89.4m due within 12 months and liabilities of NT$45.8m due beyond that. Offsetting these obligations, it had cash of NT$179.5m as well as receivables valued at NT$5.49m due within 12 months. So it can boast NT$49.8m more liquid assets than total liabilities.

This short term liquidity is a sign that Li Kang Biomedical could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Li Kang Biomedical boasts net cash, so it's fair to say it does not have a heavy debt load!

But the bad news is that Li Kang Biomedical has seen its EBIT plunge 14% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Li Kang Biomedical will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Li Kang Biomedical 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. Over the most recent three years, Li Kang Biomedical recorded free cash flow worth 79% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Li Kang Biomedical has net cash of NT$136.5m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of NT$83m, being 79% of its EBIT. So we don't think Li Kang Biomedical's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Be aware that Li Kang Biomedical is showing 2 warning signs in our investment analysis , you should know about...

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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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