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. As with many other companies Meinian Onehealth Healthcare Holdings Co., Ltd. (SZSE:002044) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

What Is Meinian Onehealth Healthcare Holdings's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Meinian Onehealth Healthcare Holdings had CN¥3.45b of debt, an increase on CN¥3.15b, over one year. However, because it has a cash reserve of CN¥2.02b, its net debt is less, at about CN¥1.42b.

How Healthy Is Meinian Onehealth Healthcare Holdings' Balance Sheet?

We can see from the most recent balance sheet that Meinian Onehealth Healthcare Holdings had liabilities of CN¥7.47b falling due within a year, and liabilities of CN¥2.94b due beyond that. Offsetting these obligations, it had cash of CN¥2.02b as well as receivables valued at CN¥3.02b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥5.37b.

While this might seem like a lot, it is not so bad since Meinian Onehealth Healthcare Holdings has a market capitalization of CN¥16.7b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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.

While Meinian Onehealth Healthcare Holdings's low debt to EBITDA ratio of 0.96 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 3.7 times last year does give us pause. So we'd recommend keeping a close eye on the impact financing costs are having on the business. Notably, Meinian Onehealth Healthcare Holdings's EBIT launched higher than Elon Musk, gaining a whopping 330% on last year. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Meinian Onehealth Healthcare Holdings 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Happily for any shareholders, Meinian Onehealth Healthcare Holdings actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

Meinian Onehealth Healthcare Holdings's conversion of EBIT to free cash flow suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But, on a more sombre note, we are a little concerned by its interest cover. It's also worth noting that Meinian Onehealth Healthcare Holdings is in the Healthcare industry, which is often considered to be quite defensive. Looking at the bigger picture, we think Meinian Onehealth Healthcare Holdings's use of debt seems quite reasonable and we're not concerned about it. While debt does bring risk, when used wisely it can also bring a higher return on equity. 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 Meinian Onehealth Healthcare Holdings's earnings per share history for free.

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.