Does Hubei Hongyuan Pharmaceutical Technology (SZSE:301246) Have A Healthy Balance Sheet?

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 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, Hubei Hongyuan Pharmaceutical Technology Co., Ltd. (SZSE:301246) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Hubei Hongyuan Pharmaceutical Technology

What Is Hubei Hongyuan Pharmaceutical Technology's Net Debt?

As you can see below, Hubei Hongyuan Pharmaceutical Technology had CN¥362.4m of debt, at September 2024, which is about the same as the year before. You can click the chart for greater detail. But it also has CN¥1.69b in cash to offset that, meaning it has CN¥1.32b net cash.

A Look At Hubei Hongyuan Pharmaceutical Technology's Liabilities

We can see from the most recent balance sheet that Hubei Hongyuan Pharmaceutical Technology had liabilities of CN¥1.18b falling due within a year, and liabilities of CN¥331.3m due beyond that. Offsetting this, it had CN¥1.69b in cash and CN¥631.2m in receivables that were due within 12 months. So it actually has CN¥807.9m more liquid assets than total liabilities.

This surplus suggests that Hubei Hongyuan Pharmaceutical Technology has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Hubei Hongyuan Pharmaceutical Technology has more cash than debt is arguably a good indication that it can manage its debt safely.

It is just as well that Hubei Hongyuan Pharmaceutical Technology's load is not too heavy, because its EBIT was down 100% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Hubei Hongyuan Pharmaceutical Technology will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Hubei Hongyuan Pharmaceutical Technology has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Hubei Hongyuan Pharmaceutical Technology burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Hubei Hongyuan Pharmaceutical Technology has net cash of CN¥1.32b, as well as more liquid assets than liabilities. So while Hubei Hongyuan Pharmaceutical Technology does not have a great balance sheet, it's certainly not too bad. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 3 warning signs for Hubei Hongyuan Pharmaceutical Technology (1 is a bit concerning!) 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.