We Think Zepp Health (NYSE:ZEPP) 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.' 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 note that Zepp Health Corporation (NYSE:ZEPP) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 Zepp Health

What Is Zepp Health's Debt?

As you can see below, at the end of March 2021, Zepp Health had CN¥833.8m of debt, up from CN¥785.7m a year ago. Click the image for more detail. However, it does have CN¥1.11b in cash offsetting this, leading to net cash of CN¥280.4m.

How Healthy Is Zepp Health's Balance Sheet?

We can see from the most recent balance sheet that Zepp Health had liabilities of CN¥2.38b falling due within a year, and liabilities of CN¥543.7m due beyond that. Offsetting these obligations, it had cash of CN¥1.11b as well as receivables valued at CN¥715.2m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥1.09b.

While this might seem like a lot, it is not so bad since Zepp Health has a market capitalization of CN¥4.38b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, Zepp Health boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that Zepp Health's load is not too heavy, because its EBIT was down 81% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Zepp Health can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Zepp Health 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 last three years, Zepp Health recorded free cash flow worth a fulsome 88% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing up

Although Zepp Health's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥280.4m. And it impressed us with free cash flow of CN¥73m, being 88% of its EBIT. So we are not troubled with Zepp Health's debt use. 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. Case in point: We've spotted 3 warning signs for Zepp Health you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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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