We Think Kangmei Pharmaceutical (SHSE:600518) Can Stay On Top Of Its Debt

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.' 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 the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. 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, Kangmei Pharmaceutical had CN¥12.2m of debt at September 2024, down from CN¥33.0m a year prior. However, it does have CN¥773.6m in cash offsetting this, leading to net cash of CN¥761.4m.

How Strong Is Kangmei Pharmaceutical's Balance Sheet?

The latest balance sheet data shows that Kangmei Pharmaceutical had liabilities of CN¥4.91b due within a year, and liabilities of CN¥2.21b falling due after that. Offsetting this, it had CN¥773.6m in cash and CN¥3.03b in receivables that were due within 12 months. So its liabilities total CN¥3.31b more than the combination of its cash and short-term receivables.

Given Kangmei Pharmaceutical has a market capitalization of CN¥30.8b, 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, Kangmei Pharmaceutical boasts net cash, so it's fair to say it does not have a heavy debt load!

Although Kangmei Pharmaceutical made a loss at the EBIT level, last year, it was also good to see that it generated CN¥278m in EBIT over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Kangmei Pharmaceutical will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. 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

Although Kangmei Pharmaceutical's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥761.4m. So we are not troubled with Kangmei Pharmaceutical's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 1 warning sign for Kangmei Pharmaceutical that you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.