These 4 Measures Indicate That Tianjin Tianyao Pharmaceuticals (SHSE:600488) Is Using Debt Reasonably Well

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 Tianjin Tianyao Pharmaceuticals Co., Ltd. (SHSE:600488) makes use of debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Tianjin Tianyao Pharmaceuticals

What Is Tianjin Tianyao Pharmaceuticals's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Tianjin Tianyao Pharmaceuticals had CN¥772.5m of debt in September 2024, down from CN¥953.4m, one year before. But it also has CN¥818.4m in cash to offset that, meaning it has CN¥46.0m net cash.

How Strong Is Tianjin Tianyao Pharmaceuticals' Balance Sheet?

We can see from the most recent balance sheet that Tianjin Tianyao Pharmaceuticals had liabilities of CN¥1.43b falling due within a year, and liabilities of CN¥699.1m due beyond that. Offsetting this, it had CN¥818.4m in cash and CN¥513.6m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥800.7m.

Given Tianjin Tianyao Pharmaceuticals has a market capitalization of CN¥4.75b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Tianjin Tianyao Pharmaceuticals boasts net cash, so it's fair to say it does not have a heavy debt load!

But the bad news is that Tianjin Tianyao Pharmaceuticals has seen its EBIT plunge 13% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Tianjin Tianyao Pharmaceuticals will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Tianjin Tianyao Pharmaceuticals 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. Happily for any shareholders, Tianjin Tianyao Pharmaceuticals actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

While Tianjin Tianyao Pharmaceuticals does have more liabilities than liquid assets, it also has net cash of CN¥46.0m. And it impressed us with free cash flow of CN¥678m, being 228% of its EBIT. So we don't have any problem with Tianjin Tianyao Pharmaceuticals's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 2 warning signs for Tianjin Tianyao Pharmaceuticals (1 is potentially serious) you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.