Is Huadong Medicine (SZSE:000963) A Risky Investment?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We note that Huadong Medicine Co., Ltd (SZSE:000963) does have debt on its balance sheet. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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.

Check out our latest analysis for Huadong Medicine

What Is Huadong Medicine's Debt?

As you can see below, Huadong Medicine had CN¥1.54b of debt at September 2023, down from CN¥2.05b a year prior. However, its balance sheet shows it holds CN¥3.93b in cash, so it actually has CN¥2.39b net cash.

How Healthy Is Huadong Medicine's Balance Sheet?

The latest balance sheet data shows that Huadong Medicine had liabilities of CN¥11.6b due within a year, and liabilities of CN¥1.41b falling due after that. On the other hand, it had cash of CN¥3.93b and CN¥10.3b worth of receivables due within a year. So it can boast CN¥1.20b more liquid assets than total liabilities.

This short term liquidity is a sign that Huadong Medicine could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Huadong Medicine has more cash than debt is arguably a good indication that it can manage its debt safely.

And we also note warmly that Huadong Medicine grew its EBIT by 19% last year, making its debt load easier to handle. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Huadong Medicine can strengthen its balance sheet over time. 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 Huadong Medicine 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, Huadong Medicine produced sturdy free cash flow equating to 62% 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 Huadong Medicine has net cash of CN¥2.39b, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 19% over the last year. So we don't think Huadong Medicine's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that Huadong Medicine is showing 1 warning sign in our investment analysis , you should know about...

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.