Is Shijiazhuang Yiling Pharmaceutical (SZSE:002603) Using Too Much Debt?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 Shijiazhuang Yiling Pharmaceutical Co., Ltd. (SZSE:002603) 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?

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 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Shijiazhuang Yiling Pharmaceutical

How Much Debt Does Shijiazhuang Yiling Pharmaceutical Carry?

As you can see below, Shijiazhuang Yiling Pharmaceutical had CN¥1.26b of debt, at June 2024, which is about the same as the year before. You can click the chart for greater detail. However, it also had CN¥1.22b in cash, and so its net debt is CN¥35.0m.

How Healthy Is Shijiazhuang Yiling Pharmaceutical's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Shijiazhuang Yiling Pharmaceutical had liabilities of CN¥4.37b due within 12 months and liabilities of CN¥1.11b due beyond that. On the other hand, it had cash of CN¥1.22b and CN¥3.11b worth of receivables due within a year. So it has liabilities totalling CN¥1.15b more than its cash and near-term receivables, combined.

Since publicly traded Shijiazhuang Yiling Pharmaceutical shares are worth a total of CN¥25.3b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. But either way, Shijiazhuang Yiling Pharmaceutical has virtually no net debt, so it's fair to say it does not have a heavy debt load!

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its 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 0.039 times EBITDA and EBIT covering interest a whopping 30.7 times, it's clear that Shijiazhuang Yiling Pharmaceutical is not a desperate borrower. Indeed relative to its earnings its debt load seems light as a feather. In fact Shijiazhuang Yiling Pharmaceutical's saving grace is its low debt levels, because its EBIT has tanked 91% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Shijiazhuang Yiling Pharmaceutical can strengthen its balance sheet over time. 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. So we always check how much of that EBIT is translated into free cash flow. Over the most recent three years, Shijiazhuang Yiling Pharmaceutical recorded free cash flow worth 71% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Shijiazhuang Yiling Pharmaceutical's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But the stark truth is that we are concerned by its EBIT growth rate. All these things considered, it appears that Shijiazhuang Yiling Pharmaceutical can comfortably handle its current debt levels. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 3 warning signs for Shijiazhuang Yiling Pharmaceutical (1 is a bit unpleasant) you should be aware of.

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.