Berkshire Hathaway’s Charlie Munger-backed outside fund manager Li Lu is quick to say, “The biggest risk in investing isn’t price volatility, but whether you’re going to suffer a permanent loss of capital “. So it may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. We can see that Shandong Weigao Group Medical Polymer Company Limited (HKG:1066) uses debt in his business. But the real question is whether this debt makes the business risky.
When is debt a problem?
Generally speaking, debt only becomes a real problem when a company cannot easily repay it, either by raising capital or with its own cash flow. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. Although not too common, we often see companies in debt permanently diluting their shareholders because lenders force them to raise capital at a ridiculous price. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. When we look at debt levels, we first consider cash and debt levels, together.
See our latest analysis for Shandong Weigao Group Medical Polymer
What is Shandong Weigao Group Medical Polymer’s debt?
The image below, which you can click for more details, shows that Shandong Weigao Group Medical Polymer had a debt of 4.06 billion yen cn end of December 2021, a reduction from 4.30 billion yen cn over a year. But on the other hand, it also has 7.51 billion Canadian yen in cash, which translates to a net cash position of 3.45 billion domestic yen.
How healthy is Shandong Weigao Group Medical Polymer’s balance sheet?
The latest balance sheet data shows that Shandong Weigao Group Medical Polymer had liabilities of 5.11 billion yen maturing within one year, and liabilities of 4.35 billion yen maturing thereafter. In compensation for these obligations, it had cash of 7.51 billion yen as well as receivables valued at 6.56 billion yen due within 12 months. He can therefore boast of having 4.61 billion yen more in liquid assets than total Passives.
This surplus suggests that Shandong Weigao Group Medical Polymer has a cautious balance sheet and could probably eliminate its debt without too much difficulty. Simply put, the fact that Shandong Weigao Group Medical Polymer has more cash than debt is arguably a good indication that it can safely manage its debt.
Also positive, Shandong Weigao Group Medical Polymer increased its EBIT by 29% over the past year, which should facilitate debt repayment in the future. When analyzing debt levels, the balance sheet is the obvious starting point. But it is future earnings, more than anything, that will determine Shandong Weigao Group Medical Polymer’s ability to maintain a healthy balance sheet in the future. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
Finally, a business needs free cash flow to pay off its debts; book profits are not enough. Although Shandong Weigao Group Medical Polymer has net cash on its balance sheet, it is still worth examining its ability to convert earnings before interest and taxes (EBIT) to free cash flow, to help us understand how quickly it builds (or erodes) this cash balance. Over the past three years, Shandong Weigao Group Medical Polymer has recorded free cash flow of 40% of EBIT, which is lower than expected. It’s not great when it comes to paying off debt.
While it’s always a good idea to investigate a company’s debt, in this case, Shandong Weigao Group Medical Polymer has a net cash position of 3.45 billion yen and a decent balance sheet. And we liked the look of EBIT growth of 29% YoY last year. We therefore do not believe Shandong Weigao Group Medical Polymer’s use of debt is risky. When analyzing debt levels, the balance sheet is the obvious starting point. But at the end of the day, every business can contain risks that exist outside of the balance sheet. For example, we have identified 1 warning sign for Shandong Weigao Group Medical Polymer of which you should be aware.
In the end, sometimes it’s easier to focus on companies that don’t even need to take on debt. Readers can access a list of growth stocks with no net debt 100% freeright now.
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