Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 can see that Vincent Medical Holdings Limited (HKG:1612) does use debt in its business. But is this debt a concern to shareholders?
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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
View our latest analysis for Vincent Medical Holdings
What Is Vincent Medical Holdings's Debt?
The image below, which you can click on for greater detail, shows that at June 2024 Vincent Medical Holdings had debt of HK$18.8m, up from HK$12.2m in one year. But it also has HK$166.7m in cash to offset that, meaning it has HK$148.0m net cash.
A Look At Vincent Medical Holdings' Liabilities
We can see from the most recent balance sheet that Vincent Medical Holdings had liabilities of HK$227.7m falling due within a year, and liabilities of HK$5.95m due beyond that. On the other hand, it had cash of HK$166.7m and HK$184.4m worth of receivables due within a year. So it can boast HK$117.5m more liquid assets than total liabilities.
This surplus liquidity suggests that Vincent Medical Holdings' balance sheet could take a hit just as well as Homer Simpson's head can take a punch. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Simply put, the fact that Vincent Medical Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.
On the other hand, Vincent Medical Holdings saw its EBIT drop by 3.7% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. 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 Vincent 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Vincent 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. Happily for any shareholders, Vincent Medical Holdings actually produced more free cash flow than EBIT over the last two years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
Summing Up
While it is always sensible to investigate a company's debt, in this case Vincent Medical Holdings has HK$148.0m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of HK$93m, being 118% of its EBIT. So we don't think Vincent Medical Holdings's use of debt is risky. 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. To that end, you should be aware of the 2 warning signs we've spotted with Vincent Medical Holdings .
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.