China National Medicines (SHSE:600511) Has A Rock Solid Balance Sheet

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, China National Medicines Corporation Ltd. (SHSE:600511) does carry debt. But the real question is whether this debt is making the company risky.

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. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for China National Medicines

What Is China National Medicines's Debt?

The image below, which you can click on for greater detail, shows that at September 2024 China National Medicines had debt of CN¥284.3m, up from CN¥222.8m in one year. But on the other hand it also has CN¥8.30b in cash, leading to a CN¥8.01b net cash position.

How Healthy Is China National Medicines' Balance Sheet?

The latest balance sheet data shows that China National Medicines had liabilities of CN¥14.6b due within a year, and liabilities of CN¥1.26b falling due after that. Offsetting these obligations, it had cash of CN¥8.30b as well as receivables valued at CN¥15.9b due within 12 months. So it actually has CN¥8.35b 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.

Fortunately, China National Medicines grew its EBIT by 2.1% in the last year, making that debt load look even more manageable. The balance sheet is clearly the area to focus on when you are analysing debt. 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 want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While China National Medicines 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. During the last three years, China National Medicines produced sturdy free cash flow equating to 80% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

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¥8.01b, as well as more liquid assets than liabilities. The cherry on top was that in converted 80% of that EBIT to free cash flow, bringing in CN¥1.5b. So is China National Medicines's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for China National Medicines you should know about.

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.