Is JiangSu WuZhong Pharmaceutical Development (SHSE:600200) A Risky Investment?

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.' 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 can see that JiangSu WuZhong Pharmaceutical Development Co., Ltd. (SHSE:600200) does use debt in its business. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for JiangSu WuZhong Pharmaceutical Development

What Is JiangSu WuZhong Pharmaceutical Development's Debt?

The chart below, which you can click on for greater detail, shows that JiangSu WuZhong Pharmaceutical Development had CN¥1.73b in debt in September 2024; about the same as the year before. However, it also had CN¥1.41b in cash, and so its net debt is CN¥317.3m.

A Look At JiangSu WuZhong Pharmaceutical Development's Liabilities

Zooming in on the latest balance sheet data, we can see that JiangSu WuZhong Pharmaceutical Development had liabilities of CN¥1.96b due within 12 months and liabilities of CN¥313.0m due beyond that. On the other hand, it had cash of CN¥1.41b and CN¥1.41b worth of receivables due within a year. So it can boast CN¥549.8m more liquid assets than total liabilities.

This surplus suggests that JiangSu WuZhong Pharmaceutical Development has a conservative balance sheet, and could probably eliminate its debt without much difficulty.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

While we wouldn't worry about JiangSu WuZhong Pharmaceutical Development's net debt to EBITDA ratio of 4.2, we think its super-low interest cover of 0.46 times is a sign of high leverage. In large part that's due to the company's significant depreciation and amortisation charges, which arguably mean its EBITDA is a very generous measure of earnings, and its debt may be more of a burden than it first appears. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. The good news is that JiangSu WuZhong Pharmaceutical Development grew its EBIT a smooth 81% over the last twelve months. Like the milk of human kindness that sort of growth increases resilience, making the company more capable of managing debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if JiangSu WuZhong Pharmaceutical Development can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the last two years, JiangSu WuZhong Pharmaceutical Development saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

JiangSu WuZhong Pharmaceutical Development's conversion of EBIT to free cash flow was a real negative on this analysis, as was its interest cover. But its EBIT growth rate was significantly redeeming. Looking at all this data makes us feel a little cautious about JiangSu WuZhong Pharmaceutical Development's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. While JiangSu WuZhong Pharmaceutical Development didn't make a statutory profit in the last year, its positive EBIT suggests that profitability might not be far away. Click here to see if its earnings are heading in the right direction, over the medium term.

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.