Does Shandong Buchang Pharmaceuticals (SHSE:603858) Have A Healthy Balance Sheet?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Shandong Buchang Pharmaceuticals Co., Ltd. (SHSE:603858) makes use of debt. But is this debt a concern to shareholders?

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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Shandong Buchang Pharmaceuticals

How Much Debt Does Shandong Buchang Pharmaceuticals Carry?

As you can see below, at the end of September 2024, Shandong Buchang Pharmaceuticals had CN¥3.82b of debt, up from CN¥3.15b a year ago. Click the image for more detail. On the flip side, it has CN¥1.31b in cash leading to net debt of about CN¥2.51b.

A Look At Shandong Buchang Pharmaceuticals' Liabilities

Zooming in on the latest balance sheet data, we can see that Shandong Buchang Pharmaceuticals had liabilities of CN¥6.08b due within 12 months and liabilities of CN¥3.27b due beyond that. On the other hand, it had cash of CN¥1.31b and CN¥1.48b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥6.55b.

This deficit isn't so bad because Shandong Buchang Pharmaceuticals is worth CN¥16.8b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

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). 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).

Shandong Buchang Pharmaceuticals has a debt to EBITDA ratio of 2.7 and its EBIT covered its interest expense 5.4 times. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. Importantly, Shandong Buchang Pharmaceuticals's EBIT fell a jaw-dropping 57% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. 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 Shandong Buchang Pharmaceuticals 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 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, Shandong Buchang Pharmaceuticals produced sturdy free cash flow equating to 72% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

Shandong Buchang Pharmaceuticals's EBIT growth rate was a real negative on this analysis, although the other factors we considered cast it in a significantly better light. In particular, its conversion of EBIT to free cash flow was re-invigorating. We think that Shandong Buchang Pharmaceuticals's debt does make it a bit risky, after considering the aforementioned data points together. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example Shandong Buchang Pharmaceuticals has 2 warning signs (and 1 which is potentially serious) we think you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.