China National Medicines (SHSE:600511) Could Easily Take On More 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. Importantly, China National Medicines Corporation Ltd. (SHSE:600511) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for China National Medicines

How Much Debt Does China National Medicines Carry?

You can click the graphic below for the historical numbers, but it shows that China National Medicines had CN¥222.8m of debt in September 2023, down from CN¥301.3m, one year before. But it also has CN¥7.85b in cash to offset that, meaning it has CN¥7.63b net cash.

How Healthy Is China National Medicines' Balance Sheet?

According to the last reported balance sheet, China National Medicines had liabilities of CN¥13.9b due within 12 months, and liabilities of CN¥950.8m due beyond 12 months. Offsetting these obligations, it had cash of CN¥7.85b as well as receivables valued at CN¥15.4b due within 12 months. So it actually has CN¥8.47b more liquid assets than total liabilities.

This luscious liquidity implies that China National Medicines' balance sheet is sturdy like a giant sequoia tree. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Simply put, the fact that China National Medicines has more cash than debt is arguably a good indication that it can manage its debt safely.

China National Medicines's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of debt. 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 China National Medicines'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, a company can only pay off debt with cold hard cash, not accounting profits. China National Medicines 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, China National Medicines produced sturdy free cash flow equating to 78% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that China National Medicines has net cash of CN¥7.63b, as well as more liquid assets than liabilities. The cherry on top was that in converted 78% of that EBIT to free cash flow, bringing in CN¥2.5b. So we don't think China National Medicines's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 1 warning sign for China National Medicines you should be aware of.

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.