Yantai Dongcheng Pharmaceutical GroupLtd (SZSE:002675) Takes On Some Risk With Its Use Of Debt

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. Importantly, Yantai Dongcheng Pharmaceutical Group Co.,Ltd. (SZSE:002675) does carry debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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 Yantai Dongcheng Pharmaceutical GroupLtd

What Is Yantai Dongcheng Pharmaceutical GroupLtd's Debt?

As you can see below, Yantai Dongcheng Pharmaceutical GroupLtd had CN¥839.7m of debt, at September 2024, which is about the same as the year before. You can click the chart for greater detail. But on the other hand it also has CN¥955.2m in cash, leading to a CN¥115.4m net cash position.

A Look At Yantai Dongcheng Pharmaceutical GroupLtd's Liabilities

According to the last reported balance sheet, Yantai Dongcheng Pharmaceutical GroupLtd had liabilities of CN¥1.66b due within 12 months, and liabilities of CN¥1.51b due beyond 12 months. On the other hand, it had cash of CN¥955.2m and CN¥967.5m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥1.25b.

Since publicly traded Yantai Dongcheng Pharmaceutical GroupLtd shares are worth a total of CN¥10.4b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Yantai Dongcheng Pharmaceutical GroupLtd also has more cash than debt, so we're pretty confident it can manage its debt safely.

Shareholders should be aware that Yantai Dongcheng Pharmaceutical GroupLtd's EBIT was down 53% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Yantai Dongcheng Pharmaceutical GroupLtd 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Yantai Dongcheng Pharmaceutical GroupLtd 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. Looking at the most recent three years, Yantai Dongcheng Pharmaceutical GroupLtd recorded free cash flow of 21% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While Yantai Dongcheng Pharmaceutical GroupLtd does have more liabilities than liquid assets, it also has net cash of CN¥115.4m. So although we see some areas for improvement, we're not too worried about Yantai Dongcheng Pharmaceutical GroupLtd's balance sheet. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Yantai Dongcheng Pharmaceutical GroupLtd you should know about.

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.