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 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. As with many other companies Medicalsystem Biotechnology Co., Ltd (SZSE:300439) makes use of debt. But should shareholders be worried about its use of debt?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does Medicalsystem Biotechnology Carry?
As you can see below, Medicalsystem Biotechnology had CN¥47.5m of debt at March 2024, down from CN¥228.7m a year prior. But it also has CN¥879.5m in cash to offset that, meaning it has CN¥832.1m net cash.
A Look At Medicalsystem Biotechnology's Liabilities
According to the last reported balance sheet, Medicalsystem Biotechnology had liabilities of CN¥576.6m due within 12 months, and liabilities of CN¥77.5m due beyond 12 months. Offsetting this, it had CN¥879.5m in cash and CN¥607.1m in receivables that were due within 12 months. So it can boast CN¥832.5m more liquid assets than total liabilities.
This surplus suggests that Medicalsystem Biotechnology is using debt in a way that is appears to be both safe and conservative. Due to its strong net asset position, it is not likely to face issues with its lenders. Simply put, the fact that Medicalsystem Biotechnology has more cash than debt is arguably a good indication that it can manage its debt safely.
On the other hand, Medicalsystem Biotechnology saw its EBIT drop by 6.4% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. When analysing debt levels, the balance sheet is the obvious place to start. But it is Medicalsystem Biotechnology's earnings that will influence how the balance sheet holds up in the future. 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. While Medicalsystem Biotechnology has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, Medicalsystem Biotechnology actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
Summing Up
While it is always sensible to investigate a company's debt, in this case Medicalsystem Biotechnology has CN¥832.1m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥255m, being 133% of its EBIT. So is Medicalsystem Biotechnology's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Medicalsystem Biotechnology is showing 1 warning sign in our investment analysis , you should know about...
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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