Heilongjiang ZBD Pharmaceutical (SHSE:603567) Seems To Use Debt Quite Sensibly

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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Heilongjiang ZBD Pharmaceutical Co., Ltd. (SHSE:603567) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Heilongjiang ZBD Pharmaceutical

What Is Heilongjiang ZBD Pharmaceutical's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 Heilongjiang ZBD Pharmaceutical had CN¥3.48b of debt, an increase on CN¥2.99b, over one year. However, because it has a cash reserve of CN¥1.22b, its net debt is less, at about CN¥2.25b.

A Look At Heilongjiang ZBD Pharmaceutical's Liabilities

According to the last reported balance sheet, Heilongjiang ZBD Pharmaceutical had liabilities of CN¥3.12b due within 12 months, and liabilities of CN¥1.48b due beyond 12 months. On the other hand, it had cash of CN¥1.22b and CN¥5.15b worth of receivables due within a year. So it actually has CN¥1.77b more liquid assets than total liabilities.

This excess liquidity suggests that Heilongjiang ZBD Pharmaceutical is taking a careful approach to debt. Because it has plenty of assets, it is unlikely to have trouble with its lenders.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Heilongjiang ZBD Pharmaceutical's net debt to EBITDA ratio of about 2.3 suggests only moderate use of debt. And its commanding EBIT of 1k times its interest expense, implies the debt load is as light as a peacock feather. We also note that Heilongjiang ZBD Pharmaceutical improved its EBIT from a last year's loss to a positive CN¥812m. There's no doubt that we learn most about debt from the balance sheet. But it is Heilongjiang ZBD 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. 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. There's no doubt that its ability to to cover its interest expense with its EBIT is pretty flash. When we consider all the elements mentioned above, it seems to us that Heilongjiang ZBD Pharmaceutical is managing its debt quite well. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. 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, we've discovered 2 warning signs for Heilongjiang ZBD Pharmaceutical (1 doesn't sit too well with us!) that you should be aware of before investing here.

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.