Is Shanghai Fosun Pharmaceutical (Group) (SHSE:600196) Using Too Much Debt?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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. As with many other companies Shanghai Fosun Pharmaceutical (Group) Co., Ltd. (SHSE:600196) makes use of debt. But the more important question is: how much risk is that debt creating?

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What Risk Does Debt Bring?

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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

How Much Debt Does Shanghai Fosun Pharmaceutical (Group) Carry?

As you can see below, Shanghai Fosun Pharmaceutical (Group) had CN¥32.6b of debt, at September 2024, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has CN¥15.6b in cash leading to net debt of about CN¥16.9b.

How Strong Is Shanghai Fosun Pharmaceutical (Group)'s Balance Sheet?

The latest balance sheet data shows that Shanghai Fosun Pharmaceutical (Group) had liabilities of CN¥37.5b due within a year, and liabilities of CN¥18.6b falling due after that. Offsetting these obligations, it had cash of CN¥15.6b as well as receivables valued at CN¥9.82b due within 12 months. So its liabilities total CN¥30.6b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Shanghai Fosun Pharmaceutical (Group) is worth CN¥60.8b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

Check out our latest analysis for Shanghai Fosun Pharmaceutical (Group)

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.

Shanghai Fosun Pharmaceutical (Group) has a debt to EBITDA ratio of 3.1, which signals significant debt, but is still pretty reasonable for most types of business. However, its interest coverage of 1k is very high, suggesting that the interest expense on the debt is currently quite low. One way Shanghai Fosun Pharmaceutical (Group) could vanquish its debt would be if it stops borrowing more but continues to grow EBIT at around 17%, as it did over the last year. 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 Shanghai Fosun Pharmaceutical (Group)'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 always check how much of that EBIT is translated into free cash flow. During the last three years, Shanghai Fosun Pharmaceutical (Group) burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Neither Shanghai Fosun Pharmaceutical (Group)'s ability to convert EBIT to free cash flow nor its net debt to EBITDA gave us confidence in its ability to take on more debt. But its interest cover tells a very different story, and suggests some resilience. We think that Shanghai Fosun Pharmaceutical (Group)'s debt does make it a bit risky, after considering the aforementioned data points together. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. 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. Case in point: We've spotted 3 warning signs for Shanghai Fosun Pharmaceutical (Group) you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.