These 4 Measures Indicate That Betta Pharmaceuticals (SZSE:300558) Is Using Debt Reasonably Well

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 Betta Pharmaceuticals Co., Ltd. (SZSE:300558) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. If things get really bad, the lenders can take control of the business. 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, 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.

See our latest analysis for Betta Pharmaceuticals

How Much Debt Does Betta Pharmaceuticals Carry?

The image below, which you can click on for greater detail, shows that at March 2024 Betta Pharmaceuticals had debt of CN¥2.48b, up from CN¥2.00b in one year. On the flip side, it has CN¥554.6m in cash leading to net debt of about CN¥1.93b.

How Healthy Is Betta Pharmaceuticals' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Betta Pharmaceuticals had liabilities of CN¥1.42b due within 12 months and liabilities of CN¥2.29b due beyond that. On the other hand, it had cash of CN¥554.6m and CN¥211.0m worth of receivables due within a year. So its liabilities total CN¥2.95b more than the combination of its cash and short-term receivables.

Betta Pharmaceuticals has a market capitalization of CN¥13.1b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Betta Pharmaceuticals has net debt to EBITDA of 2.8 suggesting it uses a fair bit of leverage to boost returns. On the plus side, its EBIT was 9.9 times its interest expense, and its net debt to EBITDA, was quite high, at 2.8. Notably, Betta Pharmaceuticals's EBIT launched higher than Elon Musk, gaining a whopping 178% on last year. 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. 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 that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Betta Pharmaceuticals's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered were considerably better. There's no doubt that its ability to to grow 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 debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 1 warning sign we've spotted with Betta Pharmaceuticals .

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.

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