We Think Huadong Medicine (SZSE:000963) Can Stay On Top Of Its Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 note that Huadong Medicine Co., Ltd (SZSE:000963) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, 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.

View our latest analysis for Huadong Medicine

What Is Huadong Medicine's Debt?

The image below, which you can click on for greater detail, shows that at September 2024 Huadong Medicine had debt of CN¥2.28b, up from CN¥1.54b in one year. But it also has CN¥4.74b in cash to offset that, meaning it has CN¥2.46b net cash.

How Strong Is Huadong Medicine's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Huadong Medicine had liabilities of CN¥14.3b due within 12 months and liabilities of CN¥591.8m due beyond that. Offsetting these obligations, it had cash of CN¥4.74b as well as receivables valued at CN¥11.1b due within 12 months. So it actually has CN¥916.4m more liquid assets than total liabilities.

This state of affairs indicates that Huadong Medicine's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the CN¥68.2b company is short on cash, but still worth keeping an eye on the balance sheet. Succinctly put, Huadong Medicine boasts net cash, so it's fair to say it does not have a heavy debt load!

The good news is that Huadong Medicine has increased its EBIT by 6.5% over twelve months, which should ease any concerns about debt repayment. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Huadong Medicine's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

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. Over the most recent three years, Huadong Medicine recorded free cash flow worth 56% of its EBIT, which is around normal, given free cash flow excludes interest and tax. 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¥2.46b, as well as more liquid assets than liabilities. So we don't think Huadong Medicine's use of debt is risky. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Huadong Medicine you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.