Here's Why Betta Pharmaceuticals (SZSE:300558) Can Manage Its Debt Responsibly

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. As with many other companies Betta Pharmaceuticals Co., Ltd. (SZSE:300558) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Betta Pharmaceuticals

How Much Debt Does Betta Pharmaceuticals Carry?

As you can see below, at the end of September 2024, Betta Pharmaceuticals had CN¥2.32b of debt, up from CN¥2.06b a year ago. Click the image for more detail. However, because it has a cash reserve of CN¥816.4m, its net debt is less, at about CN¥1.51b.

How Healthy Is Betta Pharmaceuticals' Balance Sheet?

We can see from the most recent balance sheet that Betta Pharmaceuticals had liabilities of CN¥1.78b falling due within a year, and liabilities of CN¥1.85b due beyond that. Offsetting these obligations, it had cash of CN¥816.4m as well as receivables valued at CN¥230.1m due within 12 months. So its liabilities total CN¥2.59b more than the combination of its cash and short-term receivables.

Since publicly traded Betta Pharmaceuticals shares are worth a total of CN¥21.9b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Betta Pharmaceuticals's net debt to EBITDA ratio of about 2.0 suggests only moderate use of debt. And its commanding EBIT of 11.2 times its interest expense, implies the debt load is as light as a peacock feather. We saw Betta Pharmaceuticals grow its EBIT by 5.4% in the last twelve months. That's far from incredible but it is a good thing, when it comes to paying off debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Betta Pharmaceuticals'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. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Betta Pharmaceuticals burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Based on what we've seen Betta Pharmaceuticals is not finding it easy, given its conversion of EBIT to free cash flow, but the other factors we considered give us cause to be optimistic. There's no doubt that its ability to to cover its interest expense with its EBIT is pretty flash. When we consider all the factors mentioned above, we do feel a bit cautious about Betta Pharmaceuticals's use of debt. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. 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 Betta Pharmaceuticals that you should be aware of before investing here.

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.