These 4 Measures Indicate That Guobang Pharma (SHSE:605507) Is Using Debt Extensively

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.' 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, Guobang Pharma Ltd. (SHSE:605507) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Guobang Pharma

What Is Guobang Pharma's Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Guobang Pharma had CN¥1.07b of debt, an increase on CN¥748.6m, over one year. But it also has CN¥2.38b in cash to offset that, meaning it has CN¥1.31b net cash.

How Strong Is Guobang Pharma's Balance Sheet?

We can see from the most recent balance sheet that Guobang Pharma had liabilities of CN¥2.18b falling due within a year, and liabilities of CN¥617.0m due beyond that. On the other hand, it had cash of CN¥2.38b and CN¥1.01b worth of receivables due within a year. So it can boast CN¥595.4m more liquid assets than total liabilities.

This surplus suggests that Guobang Pharma has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Guobang Pharma has more cash than debt is arguably a good indication that it can manage its debt safely.

The modesty of its debt load may become crucial for Guobang Pharma if management cannot prevent a repeat of the 33% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Guobang Pharma's ability to maintain a healthy balance sheet going forward. 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. While Guobang Pharma has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Guobang Pharma saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

While it is always sensible to investigate a company's debt, in this case Guobang Pharma has CN¥1.31b in net cash and a decent-looking balance sheet. So although we see some areas for improvement, we're not too worried about Guobang Pharma's balance sheet. 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. Be aware that Guobang Pharma 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.

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