Health Check: How Prudently Does Hunan Er-Kang Pharmaceutical (SZSE:300267) Use Debt?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We note that Hunan Er-Kang Pharmaceutical Co., Ltd (SZSE:300267) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Hunan Er-Kang Pharmaceutical

What Is Hunan Er-Kang Pharmaceutical's Debt?

As you can see below, at the end of September 2024, Hunan Er-Kang Pharmaceutical had CN¥399.4m of debt, up from CN¥149.0m a year ago. Click the image for more detail. But it also has CN¥768.4m in cash to offset that, meaning it has CN¥369.0m net cash.

How Strong Is Hunan Er-Kang Pharmaceutical's Balance Sheet?

The latest balance sheet data shows that Hunan Er-Kang Pharmaceutical had liabilities of CN¥626.9m due within a year, and liabilities of CN¥68.8m falling due after that. On the other hand, it had cash of CN¥768.4m and CN¥183.9m worth of receivables due within a year. So it can boast CN¥256.5m more liquid assets than total liabilities.

This short term liquidity is a sign that Hunan Er-Kang Pharmaceutical could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Hunan Er-Kang Pharmaceutical has more cash than debt is arguably a good indication that it can manage its debt safely. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Hunan Er-Kang Pharmaceutical's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, Hunan Er-Kang Pharmaceutical made a loss at the EBIT level, and saw its revenue drop to CN¥1.2b, which is a fall of 40%. That makes us nervous, to say the least.

So How Risky Is Hunan Er-Kang Pharmaceutical?

Although Hunan Er-Kang Pharmaceutical had an earnings before interest and tax (EBIT) loss over the last twelve months, it generated positive free cash flow of CN¥22m. So taking that on face value, and considering the net cash situation, we don't think that the stock is too 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Hunan Er-Kang Pharmaceutical you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.