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Is China Resources Medical Holdings (HKG:1515) A Risky Investment?

Simply Wall St

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital. 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. Importantly, China Resources Medical Holdings Company Limited (HKG:1515) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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.

View our latest analysis for China Resources Medical Holdings

What Is China Resources Medical Holdings's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2019 China Resources Medical Holdings had CN¥483.8m of debt, an increase on CN¥259, over one year. But on the other hand it also has CN¥1.95b in cash, leading to a CN¥1.47b net cash position.

SEHK:1515 Historical Debt, December 31st 2019

A Look At China Resources Medical Holdings's Liabilities

According to the last reported balance sheet, China Resources Medical Holdings had liabilities of CN¥1.28b due within 12 months, and liabilities of CN¥348.1m due beyond 12 months. Offsetting this, it had CN¥1.95b in cash and CN¥575.2m in receivables that were due within 12 months. So it can boast CN¥904.7m more liquid assets than total liabilities.

This surplus suggests that China Resources Medical Holdings is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that China Resources Medical Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.

Fortunately, China Resources Medical Holdings grew its EBIT by 6.8% in the last year, making that debt load look even more manageable. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine China Resources Medical Holdings's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. China Resources Medical Holdings 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, China Resources Medical Holdings produced sturdy free cash flow equating to 61% 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.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that China Resources Medical Holdings has net cash of CN¥1.47b, as well as more liquid assets than liabilities. So we don't think China Resources Medical Holdings's use of debt is risky. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of China Resources Medical Holdings's earnings per share history for free.

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.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.