Zhejiang Garden BiopharmaceuticalLtd (SZSE:300401) Has A Somewhat Strained Balance Sheet

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 can see that Zhejiang Garden Biopharmaceutical Co.,Ltd. (SZSE:300401) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Zhejiang Garden BiopharmaceuticalLtd

What Is Zhejiang Garden BiopharmaceuticalLtd's Debt?

The image below, which you can click on for greater detail, shows that at June 2024 Zhejiang Garden BiopharmaceuticalLtd had debt of CN¥1.84b, up from CN¥1.77b in one year. On the flip side, it has CN¥1.55b in cash leading to net debt of about CN¥284.4m.

How Healthy Is Zhejiang Garden BiopharmaceuticalLtd's Balance Sheet?

The latest balance sheet data shows that Zhejiang Garden BiopharmaceuticalLtd had liabilities of CN¥1.42b due within a year, and liabilities of CN¥1.03b falling due after that. Offsetting these obligations, it had cash of CN¥1.55b as well as receivables valued at CN¥122.1m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥768.7m.

Of course, Zhejiang Garden BiopharmaceuticalLtd has a market capitalization of CN¥7.42b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Zhejiang Garden BiopharmaceuticalLtd has net debt of just 0.91 times EBITDA, indicating that it is certainly not a reckless borrower. And this view is supported by the solid interest coverage, with EBIT coming in at 8.8 times the interest expense over the last year. On the other hand, Zhejiang Garden BiopharmaceuticalLtd's EBIT dived 17%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Zhejiang Garden BiopharmaceuticalLtd can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Zhejiang Garden BiopharmaceuticalLtd burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

While Zhejiang Garden BiopharmaceuticalLtd's EBIT growth rate makes us cautious about it, its track record of converting EBIT to free cash flow is no better. At least its net debt to EBITDA gives us reason to be optimistic. When we consider all the factors discussed, it seems to us that Zhejiang Garden BiopharmaceuticalLtd is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. 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. For example - Zhejiang Garden BiopharmaceuticalLtd has 2 warning signs we think you should be aware of.

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.