Is Sichuan Huiyu Pharmaceutical (SHSE:688553) 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.' 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. As with many other companies Sichuan Huiyu Pharmaceutical Co., Ltd. (SHSE:688553) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Sichuan Huiyu Pharmaceutical

What Is Sichuan Huiyu Pharmaceutical's Debt?

The image below, which you can click on for greater detail, shows that at September 2024 Sichuan Huiyu Pharmaceutical had debt of CN¥675.3m, up from CN¥201.6m in one year. But on the other hand it also has CN¥2.72b in cash, leading to a CN¥2.04b net cash position.

A Look At Sichuan Huiyu Pharmaceutical's Liabilities

Zooming in on the latest balance sheet data, we can see that Sichuan Huiyu Pharmaceutical had liabilities of CN¥1.13b due within 12 months and liabilities of CN¥44.5m due beyond that. Offsetting this, it had CN¥2.72b in cash and CN¥63.5m in receivables that were due within 12 months. So it actually has CN¥1.61b more liquid assets than total liabilities.

This surplus suggests that Sichuan Huiyu Pharmaceutical is using debt in a way that is appears to be both safe and conservative. Due to its strong net asset position, it is not likely to face issues with its lenders. Succinctly put, Sichuan Huiyu Pharmaceutical boasts net cash, so it's fair to say it does not have a heavy debt load!

Although Sichuan Huiyu Pharmaceutical made a loss at the EBIT level, last year, it was also good to see that it generated CN¥88m in EBIT over the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Sichuan Huiyu Pharmaceutical will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Sichuan Huiyu Pharmaceutical 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. During the last year, Sichuan Huiyu Pharmaceutical produced sturdy free cash flow equating to 53% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While it is always sensible to investigate a company's debt, in this case Sichuan Huiyu Pharmaceutical has CN¥2.04b in net cash and a decent-looking balance sheet. So we don't think Sichuan Huiyu Pharmaceutical's use of debt is risky. 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 Sichuan Huiyu Pharmaceutical is showing 3 warning signs in our investment analysis , and 1 of those is concerning...

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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.