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.' 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 Heilongjiang ZBD Pharmaceutical Co., Ltd. (SHSE:603567) does use debt in its business. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

View our latest analysis for Heilongjiang ZBD Pharmaceutical

How Much Debt Does Heilongjiang ZBD Pharmaceutical Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Heilongjiang ZBD Pharmaceutical had CN¥3.34b of debt, an increase on CN¥3.05b, over one year. On the flip side, it has CN¥966.2m in cash leading to net debt of about CN¥2.38b.

How Healthy Is Heilongjiang ZBD Pharmaceutical's Balance Sheet?

According to the last reported balance sheet, Heilongjiang ZBD Pharmaceutical had liabilities of CN¥2.79b due within 12 months, and liabilities of CN¥1.67b due beyond 12 months. Offsetting these obligations, it had cash of CN¥966.2m as well as receivables valued at CN¥4.82b due within 12 months. So it can boast CN¥1.33b more liquid assets than total liabilities.

This surplus suggests that Heilongjiang ZBD Pharmaceutical has a conservative balance sheet, and could probably eliminate its debt without much difficulty.

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).

Heilongjiang ZBD Pharmaceutical's net debt is 2.7 times its EBITDA, which is a significant but still reasonable amount of leverage. 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¥685m in the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. 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

Heilongjiang ZBD Pharmaceutical's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered were considerably better. In particular, we are dazzled with its interest cover. Looking at all this data makes us feel a little cautious about Heilongjiang ZBD Pharmaceutical's debt levels. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. 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. Be aware that Heilongjiang ZBD Pharmaceutical is showing 1 warning sign in our investment analysis , 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.