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.’ When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Sino Biopharmaceutical Limited (HKG:1177) does use debt in its business. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Sino Biopharmaceutical’s Debt?
As you can see below, at the end of March 2020, Sino Biopharmaceutical had CN¥13.9b of debt, up from CN¥3.35b a year ago. Click the image for more detail. But on the other hand it also has CN¥17.9b in cash, leading to a CN¥3.95b net cash position.
A Look At Sino Biopharmaceutical’s Liabilities
The latest balance sheet data shows that Sino Biopharmaceutical had liabilities of CN¥9.80b due within a year, and liabilities of CN¥15.8b falling due after that. On the other hand, it had cash of CN¥17.9b and CN¥2.76b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥4.9b.
Since publicly traded Sino Biopharmaceutical shares are worth a very impressive total of CN¥153.9b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it’s clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Sino Biopharmaceutical also has more cash than debt, so we’re pretty confident it can manage its debt safely.
The good news is that Sino Biopharmaceutical has increased its EBIT by 8.0% over twelve months, which should ease any concerns about debt repayment. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Sino Biopharmaceutical’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.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Sino Biopharmaceutical 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. During the last three years, Sino Biopharmaceutical produced sturdy free cash flow equating to 77% of its EBIT, about what we’d expect. This cold hard cash means it can reduce its debt when it wants to.
We could understand if investors are concerned about Sino Biopharmaceutical’s liabilities, but we can be reassured by the fact it has has net cash of CN¥3.95b. And it impressed us with free cash flow of CN¥3.6b, being 77% of its EBIT. So we don’t think Sino Biopharmaceutical’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. For example, we’ve discovered 2 warning signs for Sino Biopharmaceutical that you should be aware of before investing here.
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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