Is Zhejiang Wolwo Bio-Pharmaceutical (SZSE:300357) A Risky Investment?

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, Zhejiang Wolwo Bio-Pharmaceutical Co., Ltd. (SZSE:300357) does carry debt. But the real question is whether this debt is making the company risky.

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Zhejiang Wolwo Bio-Pharmaceutical

What Is Zhejiang Wolwo Bio-Pharmaceutical's Debt?

The image below, which you can click on for greater detail, shows that at September 2023 Zhejiang Wolwo Bio-Pharmaceutical had debt of CN¥14.7m, up from none in one year. But it also has CN¥1.18b in cash to offset that, meaning it has CN¥1.17b net cash.

A Look At Zhejiang Wolwo Bio-Pharmaceutical's Liabilities

According to the last reported balance sheet, Zhejiang Wolwo Bio-Pharmaceutical had liabilities of CN¥168.0m due within 12 months, and liabilities of CN¥74.7m due beyond 12 months. Offsetting this, it had CN¥1.18b in cash and CN¥297.7m in receivables that were due within 12 months. So it actually has CN¥1.24b more liquid assets than total liabilities.

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

The modesty of its debt load may become crucial for Zhejiang Wolwo Bio-Pharmaceutical if management cannot prevent a repeat of the 35% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Zhejiang Wolwo Bio-Pharmaceutical's ability to maintain a healthy balance sheet going forward. 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. Zhejiang Wolwo Bio-Pharmaceutical may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the most recent three years, Zhejiang Wolwo Bio-Pharmaceutical recorded free cash flow worth 51% 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.

Summing Up

While it is always sensible to investigate a company's debt, in this case Zhejiang Wolwo Bio-Pharmaceutical has CN¥1.17b in net cash and a decent-looking balance sheet. So we don't have any problem with Zhejiang Wolwo Bio-Pharmaceutical's use of debt. 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. For example, we've discovered 1 warning sign for Zhejiang Wolwo Bio-Pharmaceutical that you should be aware of before investing here.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.