David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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 Chimin Health Management Co., Ltd. (SHSE:603222) does use debt in its business. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
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. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Chimin Health Management's Net Debt?
As you can see below, Chimin Health Management had CN¥442.2m of debt at September 2024, down from CN¥463.0m a year prior. However, it does have CN¥290.6m in cash offsetting this, leading to net debt of about CN¥151.7m.
A Look At Chimin Health Management's Liabilities
The latest balance sheet data shows that Chimin Health Management had liabilities of CN¥453.4m due within a year, and liabilities of CN¥313.0m falling due after that. Offsetting these obligations, it had cash of CN¥290.6m as well as receivables valued at CN¥257.2m due within 12 months. So it has liabilities totalling CN¥218.6m more than its cash and near-term receivables, combined.
Since publicly traded Chimin Health Management shares are worth a total of CN¥4.12b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.
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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
Given net debt is only 1.4 times EBITDA, it is initially surprising to see that Chimin Health Management's EBIT has low interest coverage of 0.71 times. So one way or the other, it's clear the debt levels are not trivial. Shareholders should be aware that Chimin Health Management's EBIT was down 83% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. When analysing debt levels, the balance sheet is the obvious place to start. But it is Chimin Health Management'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, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. In the last three years, Chimin Health Management basically broke even on a free cash flow basis. Some might say that's a concern, when it comes considering how easily it would be for it to down debt.
Our View
To be frank both Chimin Health Management's interest cover and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. But on the bright side, its net debt to EBITDA is a good sign, and makes us more optimistic. Once we consider all the factors above, together, it seems to us that Chimin Health Management's debt is making it a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Chimin Health Management has 1 warning sign we think you should be aware of.
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.
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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.
