Is Kangmei Pharmaceutical (SHSE:600518) A Risky Investment?

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. We can see that Kangmei Pharmaceutical Co., Ltd. (SHSE:600518) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Kangmei Pharmaceutical

What Is Kangmei Pharmaceutical's Debt?

As you can see below, at the end of June 2024, Kangmei Pharmaceutical had CN¥23.4m of debt, up from CN¥11.7m a year ago. Click the image for more detail. However, it does have CN¥795.0m in cash offsetting this, leading to net cash of CN¥771.6m.

A Look At Kangmei Pharmaceutical's Liabilities

The latest balance sheet data shows that Kangmei Pharmaceutical had liabilities of CN¥4.70b due within a year, and liabilities of CN¥2.46b falling due after that. Offsetting these obligations, it had cash of CN¥795.0m as well as receivables valued at CN¥3.17b due within 12 months. So it has liabilities totalling CN¥3.20b more than its cash and near-term receivables, combined.

Since publicly traded Kangmei Pharmaceutical shares are worth a total of CN¥27.7b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Kangmei Pharmaceutical also has more cash than debt, so we're pretty confident it can manage its debt safely.

It was also good to see that despite losing money on the EBIT line last year, Kangmei Pharmaceutical turned things around in the last 12 months, delivering and EBIT of CN¥310m. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Kangmei Pharmaceutical's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Kangmei Pharmaceutical 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. During the last year, Kangmei Pharmaceutical 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.

Summing Up

While Kangmei Pharmaceutical does have more liabilities than liquid assets, it also has net cash of CN¥771.6m. So we are not troubled with Kangmei Pharmaceutical's debt use. 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. We've identified 1 warning sign with Kangmei Pharmaceutical , and understanding them should be part of your investment process.

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.