Is Zhejiang Starry PharmaceuticalLtd (SHSE:603520) Using Too Much Debt?

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 Starry Pharmaceutical Co.,Ltd. (SHSE:603520) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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. 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 step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Zhejiang Starry PharmaceuticalLtd

What Is Zhejiang Starry PharmaceuticalLtd's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2023 Zhejiang Starry PharmaceuticalLtd had debt of CN¥3.21b, up from CN¥2.74b in one year. However, it does have CN¥804.0m in cash offsetting this, leading to net debt of about CN¥2.41b.

How Healthy Is Zhejiang Starry PharmaceuticalLtd's Balance Sheet?

We can see from the most recent balance sheet that Zhejiang Starry PharmaceuticalLtd had liabilities of CN¥3.03b falling due within a year, and liabilities of CN¥910.6m due beyond that. On the other hand, it had cash of CN¥804.0m and CN¥532.2m worth of receivables due within a year. So its liabilities total CN¥2.60b more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of CN¥3.76b, so it does suggest shareholders should keep an eye on Zhejiang Starry PharmaceuticalLtd's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Weak interest cover of 1.4 times and a disturbingly high net debt to EBITDA ratio of 7.3 hit our confidence in Zhejiang Starry PharmaceuticalLtd like a one-two punch to the gut. The debt burden here is substantial. Worse, Zhejiang Starry PharmaceuticalLtd's EBIT was down 22% over the last year. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Zhejiang Starry PharmaceuticalLtd's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Zhejiang Starry PharmaceuticalLtd burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

On the face of it, Zhejiang Starry PharmaceuticalLtd's conversion of EBIT to free cash flow left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. And furthermore, its interest cover also fails to instill confidence. Taking into account all the aforementioned factors, it looks like Zhejiang Starry PharmaceuticalLtd has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. 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. Case in point: We've spotted 2 warning signs for Zhejiang Starry PharmaceuticalLtd you should be aware of.

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.