PharmaBlock Sciences (Nanjing) (SZSE:300725) Takes On Some Risk With Its Use Of Debt

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. Importantly, PharmaBlock Sciences (Nanjing), Inc. (SZSE:300725) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for PharmaBlock Sciences (Nanjing)

How Much Debt Does PharmaBlock Sciences (Nanjing) Carry?

The image below, which you can click on for greater detail, shows that PharmaBlock Sciences (Nanjing) had debt of CN¥1.49b at the end of September 2024, a reduction from CN¥1.85b over a year. However, it also had CN¥596.5m in cash, and so its net debt is CN¥896.1m.

How Strong Is PharmaBlock Sciences (Nanjing)'s Balance Sheet?

According to the last reported balance sheet, PharmaBlock Sciences (Nanjing) had liabilities of CN¥806.3m due within 12 months, and liabilities of CN¥1.21b due beyond 12 months. Offsetting these obligations, it had cash of CN¥596.5m as well as receivables valued at CN¥405.9m due within 12 months. So its liabilities total CN¥1.01b more than the combination of its cash and short-term receivables.

Given PharmaBlock Sciences (Nanjing) has a market capitalization of CN¥6.84b, it's hard to believe these liabilities pose much threat. 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

PharmaBlock Sciences (Nanjing)'s debt is 2.6 times its EBITDA, and its EBIT cover its interest expense 5.1 times over. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. Unfortunately, PharmaBlock Sciences (Nanjing)'s EBIT flopped 15% over the last four quarters. If that sort of decline is not arrested, then the managing its debt will be harder than selling broccoli flavoured ice-cream for a premium. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine PharmaBlock Sciences (Nanjing)'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 company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, PharmaBlock Sciences (Nanjing) 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

On the face of it, PharmaBlock Sciences (Nanjing)'s EBIT growth rate left us tentative about the stock, and its conversion of EBIT to free cash flow was no more enticing than the one empty restaurant on the busiest night of the year. But at least its level of total liabilities is not so bad. Once we consider all the factors above, together, it seems to us that PharmaBlock Sciences (Nanjing)'s debt is making it a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. 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 instance, we've identified 3 warning signs for PharmaBlock Sciences (Nanjing) that you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.