Here's Why Shenzhen Neptunus Bioengineering (SZSE:000078) Is Weighed Down By Its Debt Load

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Shenzhen Neptunus Bioengineering Co., Ltd. (SZSE:000078) makes use of 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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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.

View our latest analysis for Shenzhen Neptunus Bioengineering

How Much Debt Does Shenzhen Neptunus Bioengineering Carry?

As you can see below, Shenzhen Neptunus Bioengineering had CN¥11.2b of debt at March 2024, down from CN¥12.2b a year prior. However, it also had CN¥3.93b in cash, and so its net debt is CN¥7.32b.

How Strong Is Shenzhen Neptunus Bioengineering's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Shenzhen Neptunus Bioengineering had liabilities of CN¥28.0b due within 12 months and liabilities of CN¥392.7m due beyond that. Offsetting these obligations, it had cash of CN¥3.93b as well as receivables valued at CN¥20.8b due within 12 months. So its liabilities total CN¥3.72b more than the combination of its cash and short-term receivables.

Shenzhen Neptunus Bioengineering has a market capitalization of CN¥6.24b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). 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 0.67 times and a disturbingly high net debt to EBITDA ratio of 9.1 hit our confidence in Shenzhen Neptunus Bioengineering like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. Investors should also be troubled by the fact that Shenzhen Neptunus Bioengineering saw its EBIT drop by 20% over the last twelve months. If things keep going like that, handling the debt will about as easy as bundling an angry house cat into its travel box. When analysing debt levels, the balance sheet is the obvious place to start. But it is Shenzhen Neptunus Bioengineering'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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Shenzhen Neptunus Bioengineering recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Our View

On the face of it, Shenzhen Neptunus Bioengineering's net debt to EBITDA left us tentative about the stock, and its interest cover was no more enticing than the one empty restaurant on the busiest night of the year. And furthermore, its conversion of EBIT to free cash flow also fails to instill confidence. We should also note that Healthcare industry companies like Shenzhen Neptunus Bioengineering commonly do use debt without problems. Taking into account all the aforementioned factors, it looks like Shenzhen Neptunus Bioengineering has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 2 warning signs for Shenzhen Neptunus Bioengineering that you should be aware of before investing here.

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.

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