Hefei Lifeon Pharmaceutical (SZSE:003020) Has A Somewhat Strained 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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Hefei Lifeon Pharmaceutical Co., Ltd. (SZSE:003020) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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. 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.

See our latest analysis for Hefei Lifeon Pharmaceutical

How Much Debt Does Hefei Lifeon Pharmaceutical Carry?

The image below, which you can click on for greater detail, shows that at June 2024 Hefei Lifeon Pharmaceutical had debt of CN¥81.0m, up from none in one year. However, its balance sheet shows it holds CN¥425.7m in cash, so it actually has CN¥344.6m net cash.

A Look At Hefei Lifeon Pharmaceutical's Liabilities

Zooming in on the latest balance sheet data, we can see that Hefei Lifeon Pharmaceutical had liabilities of CN¥538.6m due within 12 months and liabilities of CN¥66.4m due beyond that. Offsetting this, it had CN¥425.7m in cash and CN¥402.6m in receivables that were due within 12 months. So it can boast CN¥223.3m more liquid assets than total liabilities.

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

It is just as well that Hefei Lifeon Pharmaceutical's load is not too heavy, because its EBIT was down 26% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Hefei Lifeon 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. While Hefei Lifeon 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. Considering the last three years, Hefei Lifeon Pharmaceutical actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Hefei Lifeon Pharmaceutical has net cash of CN¥344.6m, as well as more liquid assets than liabilities. So while Hefei Lifeon Pharmaceutical does not have a great balance sheet, it's certainly not too bad. 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. Case in point: We've spotted 1 warning sign for Hefei Lifeon Pharmaceutical you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.