Youcare Pharmaceutical Group (SHSE:688658) Takes On Some Risk With Its Use Of Debt

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. Importantly, Youcare Pharmaceutical Group Co., Ltd. (SHSE:688658) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. 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 step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Youcare Pharmaceutical Group

What Is Youcare Pharmaceutical Group's Debt?

The image below, which you can click on for greater detail, shows that at June 2024 Youcare Pharmaceutical Group had debt of CN¥654.3m, up from CN¥378.0m in one year. But it also has CN¥1.51b in cash to offset that, meaning it has CN¥853.2m net cash.

How Healthy Is Youcare Pharmaceutical Group's Balance Sheet?

The latest balance sheet data shows that Youcare Pharmaceutical Group had liabilities of CN¥1.82b due within a year, and liabilities of CN¥451.8m falling due after that. Offsetting this, it had CN¥1.51b in cash and CN¥951.8m in receivables that were due within 12 months. So it can boast CN¥185.0m more liquid assets than total liabilities.

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

In fact Youcare Pharmaceutical Group's saving grace is its low debt levels, because its EBIT has tanked 62% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Youcare Pharmaceutical Group can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Youcare Pharmaceutical Group 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, Youcare Pharmaceutical Group 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 we empathize with investors who find debt concerning, you should keep in mind that Youcare Pharmaceutical Group has net cash of CN¥853.2m, as well as more liquid assets than liabilities. So although we see some areas for improvement, we're not too worried about Youcare Pharmaceutical Group's balance sheet. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. We've identified 3 warning signs with Youcare Pharmaceutical Group , and understanding them should be part of your investment process.

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.