Is Sichuan Kelun Pharmaceutical (SZSE:002422) Using Too Much Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Sichuan Kelun Pharmaceutical Co., Ltd. (SZSE:002422) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Sichuan Kelun Pharmaceutical

What Is Sichuan Kelun Pharmaceutical's Debt?

You can click the graphic below for the historical numbers, but it shows that Sichuan Kelun Pharmaceutical had CN¥5.09b of debt in March 2024, down from CN¥9.46b, one year before. But on the other hand it also has CN¥6.83b in cash, leading to a CN¥1.74b net cash position.

A Look At Sichuan Kelun Pharmaceutical's Liabilities

Zooming in on the latest balance sheet data, we can see that Sichuan Kelun Pharmaceutical had liabilities of CN¥9.69b due within 12 months and liabilities of CN¥2.11b due beyond that. Offsetting these obligations, it had cash of CN¥6.83b as well as receivables valued at CN¥7.03b due within 12 months. So it actually has CN¥2.06b more liquid assets than total liabilities.

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

Also positive, Sichuan Kelun Pharmaceutical grew its EBIT by 24% in the last year, and that should make it easier to pay down debt, going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Sichuan Kelun Pharmaceutical's ability to maintain a healthy balance sheet going forward. 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. Sichuan Kelun Pharmaceutical 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. Happily for any shareholders, Sichuan Kelun Pharmaceutical actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

While it is always sensible to investigate a company's debt, in this case Sichuan Kelun Pharmaceutical has CN¥1.74b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥3.1b, being 105% of its EBIT. So we don't think Sichuan Kelun Pharmaceutical's use of debt is risky. 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 - Sichuan Kelun Pharmaceutical has 2 warning signs we think you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com