Is Anhui Huaheng Biotechnology (SHSE:688639) Using Too Much Debt?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. We note that Anhui Huaheng Biotechnology Co., Ltd. (SHSE:688639) does have debt on its balance sheet. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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 Anhui Huaheng Biotechnology

What Is Anhui Huaheng Biotechnology's Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Anhui Huaheng Biotechnology had CN¥1.59b of debt, an increase on CN¥193.9m, over one year. However, it does have CN¥370.9m in cash offsetting this, leading to net debt of about CN¥1.22b.

How Strong Is Anhui Huaheng Biotechnology's Balance Sheet?

We can see from the most recent balance sheet that Anhui Huaheng Biotechnology had liabilities of CN¥1.94b falling due within a year, and liabilities of CN¥542.6m due beyond that. On the other hand, it had cash of CN¥370.9m and CN¥334.2m worth of receivables due within a year. So its liabilities total CN¥1.78b more than the combination of its cash and short-term receivables.

Of course, Anhui Huaheng Biotechnology has a market capitalization of CN¥13.3b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Anhui Huaheng Biotechnology's net debt to EBITDA ratio of about 2.0 suggests only moderate use of debt. And its strong interest cover of 81.3 times, makes us even more comfortable. Importantly, Anhui Huaheng Biotechnology grew its EBIT by 43% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Anhui Huaheng Biotechnology'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Anhui Huaheng Biotechnology burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Anhui Huaheng Biotechnology's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered were considerably better. There's no doubt that its ability to to cover its interest expense with its EBIT is pretty flash. When we consider all the elements mentioned above, it seems to us that Anhui Huaheng Biotechnology is managing its debt quite well. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Anhui Huaheng Biotechnology is showing 3 warning signs in our investment analysis , and 2 of those are potentially serious...

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.

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