Here's Why Hunan Jiudian Pharmaceutical (SZSE:300705) Can Manage Its Debt Responsibly

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Hunan Jiudian Pharmaceutical Co., Ltd. (SZSE:300705) does use debt in its business. But should shareholders be worried about its use of debt?

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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth 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 Hunan Jiudian Pharmaceutical

How Much Debt Does Hunan Jiudian Pharmaceutical Carry?

The image below, which you can click on for greater detail, shows that at March 2024 Hunan Jiudian Pharmaceutical had debt of CN¥393.1m, up from CN¥367.1m in one year. However, its balance sheet shows it holds CN¥655.4m in cash, so it actually has CN¥262.3m net cash.

How Strong Is Hunan Jiudian Pharmaceutical's Balance Sheet?

According to the last reported balance sheet, Hunan Jiudian Pharmaceutical had liabilities of CN¥357.3m due within 12 months, and liabilities of CN¥494.1m due beyond 12 months. Offsetting these obligations, it had cash of CN¥655.4m as well as receivables valued at CN¥502.2m due within 12 months. So it can boast CN¥306.1m more liquid assets than total liabilities.

This short term liquidity is a sign that Hunan Jiudian Pharmaceutical could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Hunan Jiudian Pharmaceutical has more cash than debt is arguably a good indication that it can manage its debt safely.

In addition to that, we're happy to report that Hunan Jiudian Pharmaceutical has boosted its EBIT by 48%, thus reducing the spectre of future debt repayments. 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 Hunan Jiudian Pharmaceutical 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. Hunan Jiudian 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. In the last three years, Hunan Jiudian Pharmaceutical created free cash flow amounting to 9.0% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Hunan Jiudian Pharmaceutical has net cash of CN¥262.3m, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 48% over the last year. So is Hunan Jiudian Pharmaceutical's debt a risk? It doesn't seem so to us. 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. Be aware that Hunan Jiudian Pharmaceutical is showing 1 warning sign in our investment analysis , 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.

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