Here's Why Zhejiang Jiuzhou Pharmaceutical (SHSE:603456) Can Manage Its Debt Responsibly

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Zhejiang Jiuzhou Pharmaceutical Co., Ltd (SHSE:603456) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Zhejiang Jiuzhou Pharmaceutical

What Is Zhejiang Jiuzhou Pharmaceutical's Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Zhejiang Jiuzhou Pharmaceutical had CN¥1.70b of debt, an increase on CN¥759.5m, over one year. However, its balance sheet shows it holds CN¥4.06b in cash, so it actually has CN¥2.36b net cash.

How Strong Is Zhejiang Jiuzhou Pharmaceutical's Balance Sheet?

We can see from the most recent balance sheet that Zhejiang Jiuzhou Pharmaceutical had liabilities of CN¥2.82b falling due within a year, and liabilities of CN¥697.3m due beyond that. Offsetting this, it had CN¥4.06b in cash and CN¥1.65b in receivables that were due within 12 months. So it actually has CN¥2.19b more liquid assets than total liabilities.

This surplus suggests that Zhejiang Jiuzhou Pharmaceutical is using debt in a way that is appears to be both safe and conservative. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that Zhejiang Jiuzhou Pharmaceutical has more cash than debt is arguably a good indication that it can manage its debt safely.

On the other hand, Zhejiang Jiuzhou Pharmaceutical's EBIT dived 15%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Zhejiang Jiuzhou Pharmaceutical 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Zhejiang Jiuzhou 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. In the last three years, Zhejiang Jiuzhou Pharmaceutical's free cash flow amounted to 26% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Zhejiang Jiuzhou Pharmaceutical has net cash of CN¥2.36b, as well as more liquid assets than liabilities. So we are not troubled with Zhejiang Jiuzhou Pharmaceutical's debt use. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example Zhejiang Jiuzhou Pharmaceutical has 2 warning signs (and 1 which doesn't sit too well with us) we think you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.