Zhangzhou Pientzehuang Pharmaceutical (SHSE:600436) Seems To Use Debt Rather Sparingly

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. Importantly, Zhangzhou Pientzehuang Pharmaceutical., Ltd (SHSE:600436) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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 Zhangzhou Pientzehuang Pharmaceutical

What Is Zhangzhou Pientzehuang Pharmaceutical's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Zhangzhou Pientzehuang Pharmaceutical had CN¥1.06b of debt, an increase on CN¥843.4m, over one year. But it also has CN¥3.27b in cash to offset that, meaning it has CN¥2.21b net cash.

How Strong Is Zhangzhou Pientzehuang Pharmaceutical's Balance Sheet?

The latest balance sheet data shows that Zhangzhou Pientzehuang Pharmaceutical had liabilities of CN¥3.10b due within a year, and liabilities of CN¥289.5m falling due after that. Offsetting these obligations, it had cash of CN¥3.27b as well as receivables valued at CN¥936.3m due within 12 months. So it can boast CN¥820.1m more liquid assets than total liabilities.

Having regard to Zhangzhou Pientzehuang Pharmaceutical's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the CN¥123.0b company is struggling for cash, we still think it's worth monitoring its balance sheet. Simply put, the fact that Zhangzhou Pientzehuang Pharmaceutical has more cash than debt is arguably a good indication that it can manage its debt safely.

Fortunately, Zhangzhou Pientzehuang Pharmaceutical grew its EBIT by 7.2% in the last year, making that debt load look even more manageable. 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 Zhangzhou Pientzehuang Pharmaceutical can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Zhangzhou Pientzehuang Pharmaceutical 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. Happily for any shareholders, Zhangzhou Pientzehuang Pharmaceutical actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While it is always sensible to investigate a company's debt, in this case Zhangzhou Pientzehuang Pharmaceutical has CN¥2.21b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥1.0b, being 102% of its EBIT. So is Zhangzhou Pientzehuang Pharmaceutical's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Zhangzhou Pientzehuang Pharmaceutical is showing 1 warning sign in our investment analysis , you should know about...

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.