Shenzhen YHLO Biotech (SHSE:688575) Has A Pretty Healthy Balance Sheet

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Shenzhen YHLO Biotech Co., Ltd. (SHSE:688575) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Shenzhen YHLO Biotech

How Much Debt Does Shenzhen YHLO Biotech Carry?

The image below, which you can click on for greater detail, shows that at September 2024 Shenzhen YHLO Biotech had debt of CN¥842.0m, up from CN¥647.9m in one year. However, because it has a cash reserve of CN¥578.4m, its net debt is less, at about CN¥263.6m.

How Strong Is Shenzhen YHLO Biotech's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Shenzhen YHLO Biotech had liabilities of CN¥887.7m due within 12 months and liabilities of CN¥600.0m due beyond that. On the other hand, it had cash of CN¥578.4m and CN¥443.1m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥466.2m.

Given Shenzhen YHLO Biotech has a market capitalization of CN¥9.96b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Shenzhen YHLO Biotech has a low net debt to EBITDA ratio of only 0.58. And its EBIT easily covers its interest expense, being 88.1 times the size. So we're pretty relaxed about its super-conservative use of debt. It is just as well that Shenzhen YHLO Biotech's load is not too heavy, because its EBIT was down 33% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. 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 Shenzhen YHLO Biotech'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.

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, Shenzhen YHLO Biotech created free cash flow amounting to 8.9% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

Based on what we've seen Shenzhen YHLO Biotech is not finding it easy, given its EBIT growth rate, but the other factors we considered give us cause to be optimistic. In particular, we are dazzled with its interest cover. We would also note that Medical Equipment industry companies like Shenzhen YHLO Biotech commonly do use debt without problems. Looking at all this data makes us feel a little cautious about Shenzhen YHLO Biotech's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 1 warning sign with Shenzhen YHLO Biotech , and understanding them should be part of your investment process.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.