Is Sichuan Hebang Biotechnology (SHSE:603077) A Risky Investment?

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.' 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. Importantly, Sichuan Hebang Biotechnology Corporation Limited (SHSE:603077) does carry debt. But the real question is whether this debt is making the company risky.

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. If things get really bad, the lenders can take control of the business. 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. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Sichuan Hebang Biotechnology

How Much Debt Does Sichuan Hebang Biotechnology Carry?

The image below, which you can click on for greater detail, shows that at September 2023 Sichuan Hebang Biotechnology had debt of CN¥1.95b, up from CN¥1.65b in one year. However, its balance sheet shows it holds CN¥3.88b in cash, so it actually has CN¥1.93b net cash.

How Strong Is Sichuan Hebang Biotechnology's Balance Sheet?

According to the last reported balance sheet, Sichuan Hebang Biotechnology had liabilities of CN¥3.57b due within 12 months, and liabilities of CN¥867.7m due beyond 12 months. Offsetting this, it had CN¥3.88b in cash and CN¥2.08b in receivables that were due within 12 months. So it actually has CN¥1.52b more liquid assets than total liabilities.

This surplus suggests that Sichuan Hebang Biotechnology has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Sichuan Hebang Biotechnology has more cash than debt is arguably a good indication that it can manage its debt safely.

In fact Sichuan Hebang Biotechnology's saving grace is its low debt levels, because its EBIT has tanked 69% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Sichuan Hebang Biotechnology will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Sichuan Hebang Biotechnology may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. In the last three years, Sichuan Hebang Biotechnology's free cash flow amounted to 32% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Sichuan Hebang Biotechnology has net cash of CN¥1.93b, as well as more liquid assets than liabilities. So we don't have any problem with Sichuan Hebang Biotechnology's use of debt. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Sichuan Hebang Biotechnology 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.