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. Importantly, Qingdao Baheal Medical INC. (SZSE:301015) does carry debt. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.
What Is Qingdao Baheal Medical's Debt?
As you can see below, at the end of September 2023, Qingdao Baheal Medical had CN¥1.24b of debt, up from CN¥1.13b a year ago. Click the image for more detail. However, it does have CN¥1.03b in cash offsetting this, leading to net debt of about CN¥210.7m.
How Healthy Is Qingdao Baheal Medical's Balance Sheet?
According to the last reported balance sheet, Qingdao Baheal Medical had liabilities of CN¥1.92b due within 12 months, and liabilities of CN¥917.9m due beyond 12 months. Offsetting this, it had CN¥1.03b in cash and CN¥2.48b in receivables that were due within 12 months. So it actually has CN¥665.2m more liquid assets than total liabilities.
This surplus suggests that Qingdao Baheal Medical has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Carrying virtually no net debt, Qingdao Baheal Medical has a very light debt load indeed.
We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Qingdao Baheal Medical has a low debt to EBITDA ratio of only 0.23. But the really cool thing is that it actually managed to receive more interest than it paid, over the last year. So there's no doubt this company can take on debt while staying cool as a cucumber. Another good sign is that Qingdao Baheal Medical has been able to increase its EBIT by 25% in twelve months, making it easier to pay down debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Qingdao Baheal Medical's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the most recent three years, Qingdao Baheal Medical recorded free cash flow worth 52% 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.
Our View
The good news is that Qingdao Baheal Medical's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And the good news does not stop there, as its net debt to EBITDA also supports that impression! It's also worth noting that Qingdao Baheal Medical is in the Healthcare industry, which is often considered to be quite defensive. Considering this range of factors, it seems to us that Qingdao Baheal Medical is quite prudent with its debt, and the risks seem well managed. So we're not worried about the use of a little leverage on the balance sheet. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 1 warning sign for Qingdao Baheal Medical you should be aware of.
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.