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.' 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. We can see that APT Medical Inc. (SHSE:688617) 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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is APT Medical's Net Debt?
As you can see below, APT Medical had CN¥10.8m of debt at March 2024, down from CN¥115.9m a year prior. However, it does have CN¥1.23b in cash offsetting this, leading to net cash of CN¥1.22b.
How Healthy Is APT Medical's Balance Sheet?
According to the last reported balance sheet, APT Medical had liabilities of CN¥486.4m due within 12 months, and liabilities of CN¥18.5m due beyond 12 months. Offsetting this, it had CN¥1.23b in cash and CN¥47.3m in receivables that were due within 12 months. So it can boast CN¥772.3m more liquid assets than total liabilities.
This surplus suggests that APT Medical has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that APT Medical has more cash than debt is arguably a good indication that it can manage its debt safely.
On top of that, APT Medical grew its EBIT by 36% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if APT Medical 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.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While APT Medical 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. Over the most recent three years, APT Medical recorded free cash flow worth 59% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.
Summing Up
While we empathize with investors who find debt concerning, you should keep in mind that APT Medical has net cash of CN¥1.22b, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 36% over the last year. So is APT Medical'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. However, not all investment risk resides within the balance sheet - far from it. For example - APT Medical has 1 warning sign we think you should be aware of.
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.
