Is Shijiazhuang Yiling Pharmaceutical (SZSE:002603) A Risky Investment?

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.' 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. We note that Shijiazhuang Yiling Pharmaceutical Co., Ltd. (SZSE:002603) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Shijiazhuang Yiling Pharmaceutical

How Much Debt Does Shijiazhuang Yiling Pharmaceutical Carry?

The image below, which you can click on for greater detail, shows that at March 2024 Shijiazhuang Yiling Pharmaceutical had debt of CN¥1.40b, up from CN¥1.06b in one year. On the flip side, it has CN¥1.30b in cash leading to net debt of about CN¥99.0m.

How Strong Is Shijiazhuang Yiling Pharmaceutical's Balance Sheet?

The latest balance sheet data shows that Shijiazhuang Yiling Pharmaceutical had liabilities of CN¥4.29b due within a year, and liabilities of CN¥1.10b falling due after that. On the other hand, it had cash of CN¥1.30b and CN¥3.11b worth of receivables due within a year. So it has liabilities totalling CN¥976.3m more than its cash and near-term receivables, combined.

Given Shijiazhuang Yiling Pharmaceutical has a market capitalization of CN¥31.0b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Carrying virtually no net debt, Shijiazhuang Yiling Pharmaceutical has a very light debt load indeed.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

With debt at a measly 0.092 times EBITDA and EBIT covering interest a whopping 191 times, it's clear that Shijiazhuang Yiling Pharmaceutical is not a desperate borrower. So relative to past earnings, the debt load seems trivial. It is just as well that Shijiazhuang Yiling Pharmaceutical's load is not too heavy, because its EBIT was down 86% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Shijiazhuang Yiling 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, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Shijiazhuang Yiling Pharmaceutical produced sturdy free cash flow equating to 59% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

Shijiazhuang Yiling Pharmaceutical's EBIT growth rate was a real negative on this analysis, although the other factors we considered were considerably better. There's no doubt that its ability to to cover its interest expense with its EBIT is pretty flash. Considering this range of data points, we think Shijiazhuang Yiling Pharmaceutical is in a good position to manage its debt levels. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. 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 instance, we've identified 2 warning signs for Shijiazhuang Yiling Pharmaceutical (1 is potentially serious) 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.