We Think Northeast Pharmaceutical Group (SZSE:000597) Can Manage Its Debt With Ease

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. As with many other companies Northeast Pharmaceutical Group Co., Ltd. (SZSE:000597) makes use of 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 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Northeast Pharmaceutical Group

What Is Northeast Pharmaceutical Group's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Northeast Pharmaceutical Group had CN¥2.12b of debt in September 2024, down from CN¥2.53b, one year before. However, its balance sheet shows it holds CN¥5.08b in cash, so it actually has CN¥2.95b net cash.

How Healthy Is Northeast Pharmaceutical Group's Balance Sheet?

We can see from the most recent balance sheet that Northeast Pharmaceutical Group had liabilities of CN¥8.79b falling due within a year, and liabilities of CN¥350.8m due beyond that. On the other hand, it had cash of CN¥5.08b and CN¥2.93b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥1.14b.

Since publicly traded Northeast Pharmaceutical Group shares are worth a total of CN¥7.96b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Northeast Pharmaceutical Group boasts net cash, so it's fair to say it does not have a heavy debt load!

And we also note warmly that Northeast Pharmaceutical Group grew its EBIT by 11% last year, making its debt load easier to handle. The balance sheet is clearly the area to focus on when you are analysing debt. 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. 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 generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

While Northeast Pharmaceutical Group does have more liabilities than liquid assets, it also has net cash of CN¥2.95b. The cherry on top was that in converted 192% of that EBIT to free cash flow, bringing in CN¥494m. So is Northeast Pharmaceutical Group's debt a risk? It doesn't seem so to us. 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. Be aware that Northeast Pharmaceutical Group 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.