These 4 Measures Indicate That Northeast Pharmaceutical Group (SZSE:000597) Is Using Debt Safely

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, Northeast Pharmaceutical Group Co., Ltd. (SZSE:000597) does carry debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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.

See our latest analysis for Northeast Pharmaceutical Group

How Much Debt Does Northeast Pharmaceutical Group Carry?

As you can see below, Northeast Pharmaceutical Group had CN¥2.39b of debt, at March 2024, which is about the same as the year before. You can click the chart for greater detail. However, its balance sheet shows it holds CN¥5.82b in cash, so it actually has CN¥3.43b net cash.

How Strong Is Northeast Pharmaceutical Group's Balance Sheet?

According to the last reported balance sheet, Northeast Pharmaceutical Group had liabilities of CN¥9.92b due within 12 months, and liabilities of CN¥459.0m due beyond 12 months. Offsetting this, it had CN¥5.82b in cash and CN¥2.87b in receivables that were due within 12 months. So its liabilities total CN¥1.69b more than the combination of its cash and short-term receivables.

Northeast Pharmaceutical Group has a market capitalization of CN¥6.39b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Despite its noteworthy liabilities, Northeast Pharmaceutical Group boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Northeast Pharmaceutical Group grew its EBIT by 53% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is Northeast Pharmaceutical Group's earnings that will influence how the balance sheet holds up in the future. 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. Northeast 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, Northeast Pharmaceutical Group actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

Although Northeast Pharmaceutical Group's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥3.43b. And it impressed us with free cash flow of CN¥318m, being 237% of its EBIT. So we don't think Northeast Pharmaceutical Group's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Northeast Pharmaceutical Group is showing 2 warning signs 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.