Does Guangdong Zhongsheng Pharmaceutical (SZSE:002317) Have A Healthy Balance Sheet?

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. We note that Guangdong Zhongsheng Pharmaceutical Co., Ltd. (SZSE:002317) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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 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 think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Guangdong Zhongsheng Pharmaceutical

What Is Guangdong Zhongsheng Pharmaceutical's Net Debt?

The image below, which you can click on for greater detail, shows that Guangdong Zhongsheng Pharmaceutical had debt of CN¥698.7m at the end of September 2023, a reduction from CN¥1.15b over a year. But on the other hand it also has CN¥1.96b in cash, leading to a CN¥1.26b net cash position.

How Strong Is Guangdong Zhongsheng Pharmaceutical's Balance Sheet?

According to the last reported balance sheet, Guangdong Zhongsheng Pharmaceutical had liabilities of CN¥935.3m due within 12 months, and liabilities of CN¥925.0m due beyond 12 months. Offsetting this, it had CN¥1.96b in cash and CN¥1.05b in receivables that were due within 12 months. So it actually has CN¥1.15b more liquid assets than total liabilities.

This surplus suggests that Guangdong Zhongsheng Pharmaceutical has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Guangdong Zhongsheng Pharmaceutical boasts net cash, so it's fair to say it does not have a heavy debt load!

On the other hand, Guangdong Zhongsheng Pharmaceutical saw its EBIT drop by 4.5% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Guangdong Zhongsheng Pharmaceutical's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Guangdong Zhongsheng 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. Over the last three years, Guangdong Zhongsheng Pharmaceutical 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.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Guangdong Zhongsheng Pharmaceutical has net cash of CN¥1.26b, as well as more liquid assets than liabilities. So we are not troubled with Guangdong Zhongsheng Pharmaceutical's debt use. 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. Case in point: We've spotted 3 warning signs for Guangdong Zhongsheng Pharmaceutical you should be aware of, and 1 of them makes us a bit uncomfortable.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.