Does C.Q. Pharmaceutical Holding (SZSE:000950) Have A Healthy 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.' 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. Importantly, C.Q. Pharmaceutical Holding Co., Ltd. (SZSE:000950) does carry debt. But should shareholders be worried about its use of debt?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for C.Q. Pharmaceutical Holding

What Is C.Q. Pharmaceutical Holding's Net Debt?

As you can see below, C.Q. Pharmaceutical Holding had CN¥24.7b of debt, at September 2023, which is about the same as the year before. You can click the chart for greater detail. However, because it has a cash reserve of CN¥8.07b, its net debt is less, at about CN¥16.7b.

A Look At C.Q. Pharmaceutical Holding's Liabilities

The latest balance sheet data shows that C.Q. Pharmaceutical Holding had liabilities of CN¥44.7b due within a year, and liabilities of CN¥4.95b falling due after that. On the other hand, it had cash of CN¥8.07b and CN¥37.7b worth of receivables due within a year. So it has liabilities totalling CN¥3.82b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since C.Q. Pharmaceutical Holding has a market capitalization of CN¥8.68b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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

Weak interest cover of 2.0 times and a disturbingly high net debt to EBITDA ratio of 7.6 hit our confidence in C.Q. Pharmaceutical Holding like a one-two punch to the gut. The debt burden here is substantial. Another concern for investors might be that C.Q. Pharmaceutical Holding's EBIT fell 16% in the last year. If that's the way things keep going handling the debt load will be like delivering hot coffees on a pogo stick. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if C.Q. Pharmaceutical Holding can strengthen its balance sheet over time. 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. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, C.Q. Pharmaceutical Holding saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

On the face of it, C.Q. Pharmaceutical Holding's net debt to EBITDA left us tentative about the stock, and its conversion of EBIT to free cash flow was no more enticing than the one empty restaurant on the busiest night of the year. Having said that, its ability to handle its total liabilities isn't such a worry. We should also note that Healthcare industry companies like C.Q. Pharmaceutical Holding commonly do use debt without problems. We're quite clear that we consider C.Q. Pharmaceutical Holding to be really rather risky, as a result of its balance sheet health. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. 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 3 warning signs for C.Q. Pharmaceutical Holding (of which 1 is a bit unpleasant!) you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.