Is Aurisco PharmaceuticalLtd (SHSE:605116) A Risky Investment?

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 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, Aurisco Pharmaceutical Co.,Ltd. (SHSE:605116) does carry debt. But the more important question is: how much risk is that debt creating?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Aurisco PharmaceuticalLtd

How Much Debt Does Aurisco PharmaceuticalLtd Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 Aurisco PharmaceuticalLtd had CN¥186.0m of debt, an increase on CN¥44.9m, over one year. However, it does have CN¥446.9m in cash offsetting this, leading to net cash of CN¥260.9m.

How Strong Is Aurisco PharmaceuticalLtd's Balance Sheet?

According to the last reported balance sheet, Aurisco PharmaceuticalLtd had liabilities of CN¥622.9m due within 12 months, and liabilities of CN¥166.7m due beyond 12 months. Offsetting these obligations, it had cash of CN¥446.9m as well as receivables valued at CN¥357.9m due within 12 months. So these liquid assets roughly match the total liabilities.

Having regard to Aurisco PharmaceuticalLtd's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the CN¥8.29b company is short on cash, but still worth keeping an eye on the balance sheet. Simply put, the fact that Aurisco PharmaceuticalLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

In addition to that, we're happy to report that Aurisco PharmaceuticalLtd has boosted its EBIT by 94%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Aurisco PharmaceuticalLtd can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Aurisco PharmaceuticalLtd may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Aurisco PharmaceuticalLtd recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Summing Up

While it is always sensible to investigate a company's debt, in this case Aurisco PharmaceuticalLtd has CN¥260.9m in net cash and a decent-looking balance sheet. And we liked the look of last year's 94% year-on-year EBIT growth. So we don't have any problem with Aurisco PharmaceuticalLtd's use of debt. 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. For instance, we've identified 2 warning signs for Aurisco PharmaceuticalLtd (1 can't be ignored) you should be aware of.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.