ShuYu Civilian Pharmacy (SZSE:301017) Has A Somewhat Strained Balance Sheet

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.' 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. Importantly, ShuYu Civilian Pharmacy Corp., Ltd. (SZSE:301017) does carry debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth 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.

See our latest analysis for ShuYu Civilian Pharmacy

What Is ShuYu Civilian Pharmacy's Net Debt?

As you can see below, at the end of September 2024, ShuYu Civilian Pharmacy had CN¥3.64b of debt, up from CN¥2.95b a year ago. Click the image for more detail. However, because it has a cash reserve of CN¥1.34b, its net debt is less, at about CN¥2.30b.

A Look At ShuYu Civilian Pharmacy's Liabilities

Zooming in on the latest balance sheet data, we can see that ShuYu Civilian Pharmacy had liabilities of CN¥5.28b due within 12 months and liabilities of CN¥1.71b due beyond that. Offsetting these obligations, it had cash of CN¥1.34b as well as receivables valued at CN¥1.49b due within 12 months. So its liabilities total CN¥4.16b more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of CN¥5.31b, so it does suggest shareholders should keep an eye on ShuYu Civilian Pharmacy's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its 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).

Weak interest cover of 0.72 times and a disturbingly high net debt to EBITDA ratio of 15.3 hit our confidence in ShuYu Civilian Pharmacy like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. Worse, ShuYu Civilian Pharmacy's EBIT was down 82% over the last year. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is ShuYu Civilian Pharmacy'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. In the last three years, ShuYu Civilian Pharmacy created free cash flow amounting to 20% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

To be frank both ShuYu Civilian Pharmacy's interest cover and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. And even its conversion of EBIT to free cash flow fails to inspire much confidence. Taking into account all the aforementioned factors, it looks like ShuYu Civilian Pharmacy has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. 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. To that end, you should be aware of the 2 warning signs we've spotted with ShuYu Civilian Pharmacy .

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.