Does Heilongjiang ZBD Pharmaceutical (SHSE:603567) Have A Healthy Balance Sheet?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. Importantly, Heilongjiang ZBD Pharmaceutical Co., Ltd. (SHSE:603567) does carry debt. But the real question is whether this debt is making the company risky.

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest 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 Heilongjiang ZBD Pharmaceutical

How Much Debt Does Heilongjiang ZBD Pharmaceutical Carry?

The image below, which you can click on for greater detail, shows that at March 2024 Heilongjiang ZBD Pharmaceutical had debt of CN¥3.29b, up from CN¥2.92b in one year. However, it also had CN¥1.40b in cash, and so its net debt is CN¥1.89b.

How Healthy Is Heilongjiang ZBD Pharmaceutical's Balance Sheet?

According to the last reported balance sheet, Heilongjiang ZBD Pharmaceutical had liabilities of CN¥2.95b due within 12 months, and liabilities of CN¥1.59b due beyond 12 months. Offsetting this, it had CN¥1.40b in cash and CN¥5.16b in receivables that were due within 12 months. So it can boast CN¥2.02b more liquid assets than total liabilities.

It's good to see that Heilongjiang ZBD Pharmaceutical has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Due to its strong net asset position, it is not likely to face issues with its lenders.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Heilongjiang ZBD Pharmaceutical has a debt to EBITDA ratio of 4.3, which signals significant debt, but is still pretty reasonable for most types of business. But its EBIT was about 1k times its interest expense, implying the company isn't really paying a high cost to maintain that level of debt. Even were the low cost to prove unsustainable, that is a good sign. Notably, Heilongjiang ZBD Pharmaceutical made a loss at the EBIT level, last year, but improved that to positive EBIT of CN¥259m in 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 Heilongjiang ZBD 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Over the last year, Heilongjiang ZBD Pharmaceutical saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Based on what we've seen Heilongjiang ZBD Pharmaceutical is not finding it easy, given its conversion of EBIT to free cash flow, but the other factors we considered give us cause to be optimistic. In particular, we are dazzled with its interest cover. When we consider all the factors mentioned above, we do feel a bit cautious about Heilongjiang ZBD Pharmaceutical's use of debt. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. 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. To that end, you should learn about the 2 warning signs we've spotted with Heilongjiang ZBD Pharmaceutical (including 1 which is significant) .

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.