Health Check: How Prudently Does Chongqing Lummy Pharmaceutical (SZSE:300006) Use 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. We note that Chongqing Lummy Pharmaceutical Co., Ltd. (SZSE:300006) does have debt on its balance sheet. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Chongqing Lummy Pharmaceutical

How Much Debt Does Chongqing Lummy Pharmaceutical Carry?

The image below, which you can click on for greater detail, shows that at September 2024 Chongqing Lummy Pharmaceutical had debt of CN¥394.4m, up from CN¥290.3m in one year. However, its balance sheet shows it holds CN¥1.09b in cash, so it actually has CN¥699.8m net cash.

How Healthy Is Chongqing Lummy Pharmaceutical's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Chongqing Lummy Pharmaceutical had liabilities of CN¥781.9m due within 12 months and liabilities of CN¥147.4m due beyond that. Offsetting these obligations, it had cash of CN¥1.09b as well as receivables valued at CN¥482.7m due within 12 months. So it actually has CN¥647.6m more liquid assets than total liabilities.

This surplus suggests that Chongqing Lummy Pharmaceutical is using debt in a way that is appears to be both safe and conservative. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that Chongqing Lummy Pharmaceutical has more cash than debt is arguably a good indication that it can manage its debt safely. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Chongqing Lummy Pharmaceutical will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year Chongqing Lummy Pharmaceutical's revenue was pretty flat, and it made a negative EBIT. While that's not too bad, we'd prefer see growth.

So How Risky Is Chongqing Lummy Pharmaceutical?

While Chongqing Lummy Pharmaceutical lost money on an earnings before interest and tax (EBIT) level, it actually booked a paper profit of CN¥19m. So taking that on face value, and considering the cash, we don't think its very risky in the near term. We'll feel more comfortable with the stock once EBIT is positive, given the lacklustre revenue growth. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 2 warning signs we've spotted with Chongqing Lummy Pharmaceutical (including 1 which is a bit concerning) .

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.