Is LBX Pharmacy Chain (SHSE:603883) Using Too Much Debt?

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 note that LBX Pharmacy Chain Joint Stock Company (SHSE:603883) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for LBX Pharmacy Chain

What Is LBX Pharmacy Chain's Net Debt?

As you can see below, at the end of September 2024, LBX Pharmacy Chain had CN¥4.03b of debt, up from CN¥3.87b a year ago. Click the image for more detail. On the flip side, it has CN¥2.10b in cash leading to net debt of about CN¥1.93b.

A Look At LBX Pharmacy Chain's Liabilities

The latest balance sheet data shows that LBX Pharmacy Chain had liabilities of CN¥10.1b due within a year, and liabilities of CN¥3.51b falling due after that. On the other hand, it had cash of CN¥2.10b and CN¥2.36b worth of receivables due within a year. So it has liabilities totalling CN¥9.20b more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of CN¥13.2b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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).

LBX Pharmacy Chain's net debt is only 1.2 times its EBITDA. And its EBIT easily covers its interest expense, being 14.8 times the size. So we're pretty relaxed about its super-conservative use of debt. But the other side of the story is that LBX Pharmacy Chain saw its EBIT decline by 8.2% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine LBX Pharmacy Chain'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. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Happily for any shareholders, LBX Pharmacy Chain actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

LBX Pharmacy Chain's interest cover was a real positive on this analysis, as was its conversion of EBIT to free cash flow. On the other hand, its EBIT growth rate makes us a little less comfortable about its debt. Considering this range of data points, we think LBX Pharmacy Chain is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. 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. Case in point: We've spotted 1 warning sign for LBX Pharmacy Chain you should be aware of.

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.