Anhui Huaren Health Pharmaceutical (SZSE:301408) Takes On Some Risk With Its Use Of Debt

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Anhui Huaren Health Pharmaceutical Co., Ltd. (SZSE:301408) does have debt on its balance sheet. 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. 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. 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.

Check out our latest analysis for Anhui Huaren Health Pharmaceutical

How Much Debt Does Anhui Huaren Health Pharmaceutical Carry?

As you can see below, at the end of September 2024, Anhui Huaren Health Pharmaceutical had CN¥1.07b of debt, up from CN¥454.0m a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥1.20b in cash, so it actually has CN¥125.6m net cash.

How Healthy Is Anhui Huaren Health Pharmaceutical's Balance Sheet?

We can see from the most recent balance sheet that Anhui Huaren Health Pharmaceutical had liabilities of CN¥2.17b falling due within a year, and liabilities of CN¥769.0m due beyond that. Offsetting this, it had CN¥1.20b in cash and CN¥562.1m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥1.18b.

Anhui Huaren Health Pharmaceutical has a market capitalization of CN¥5.07b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Despite its noteworthy liabilities, Anhui Huaren Health Pharmaceutical boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Anhui Huaren Health Pharmaceutical if management cannot prevent a repeat of the 22% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. There's no doubt that we learn most about debt from the balance sheet. But it is Anhui Huaren Health Pharmaceutical's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Anhui Huaren Health Pharmaceutical has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. In the last three years, Anhui Huaren Health Pharmaceutical's free cash flow amounted to 30% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

Although Anhui Huaren Health Pharmaceutical's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥125.6m. So although we see some areas for improvement, we're not too worried about Anhui Huaren Health Pharmaceutical's balance sheet. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for Anhui Huaren Health Pharmaceutical that you should be aware of before investing here.

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.