These 4 Measures Indicate That Wanbangde Pharmaceutical Holding Group (SZSE:002082) Is Using Debt Extensively

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. We note that Wanbangde Pharmaceutical Holding Group Co., Ltd. (SZSE:002082) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Wanbangde Pharmaceutical Holding Group

What Is Wanbangde Pharmaceutical Holding Group's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Wanbangde Pharmaceutical Holding Group had CN¥948.2m of debt in September 2024, down from CN¥1.09b, one year before. On the flip side, it has CN¥95.8m in cash leading to net debt of about CN¥852.4m.

How Healthy Is Wanbangde Pharmaceutical Holding Group's Balance Sheet?

According to the last reported balance sheet, Wanbangde Pharmaceutical Holding Group had liabilities of CN¥1.29b due within 12 months, and liabilities of CN¥211.8m due beyond 12 months. Offsetting this, it had CN¥95.8m in cash and CN¥1.05b in receivables that were due within 12 months. So its liabilities total CN¥361.8m more than the combination of its cash and short-term receivables.

Of course, Wanbangde Pharmaceutical Holding Group has a market capitalization of CN¥4.02b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Weak interest cover of 1.9 times and a disturbingly high net debt to EBITDA ratio of 5.6 hit our confidence in Wanbangde Pharmaceutical Holding Group like a one-two punch to the gut. The debt burden here is substantial. The good news is that Wanbangde Pharmaceutical Holding Group improved its EBIT by 9.9% over the last twelve months, thus gradually reducing its debt levels relative to its earnings. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Wanbangde Pharmaceutical Holding Group will need earnings to service that debt. 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. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Wanbangde Pharmaceutical Holding Group 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.

Our View

To be frank both Wanbangde Pharmaceutical Holding Group's net debt to EBITDA and its track record of converting EBIT to free cash flow make us rather uncomfortable with its debt levels. But at least it's pretty decent at growing its EBIT; that's encouraging. Once we consider all the factors above, together, it seems to us that Wanbangde Pharmaceutical Holding Group's debt is making it a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 3 warning signs for Wanbangde Pharmaceutical Holding Group (1 can't be ignored!) that you should be aware of before investing here.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.