Here's Why Sinopharm Group (HKG:1099) Can Manage Its Debt Responsibly

Warren Buffett famously said, '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. As with many other companies Sinopharm Group Co., Ltd. (HKG:1099) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Sinopharm Group

What Is Sinopharm Group's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Sinopharm Group had CN¥62.7b of debt in March 2021, down from CN¥83.8b, one year before. However, it also had CN¥38.2b in cash, and so its net debt is CN¥24.5b.

How Strong Is Sinopharm Group's Balance Sheet?

According to the last reported balance sheet, Sinopharm Group had liabilities of CN¥220.1b due within 12 months, and liabilities of CN¥18.4b due beyond 12 months. Offsetting these obligations, it had cash of CN¥38.2b as well as receivables valued at CN¥186.6b due within 12 months. So it has liabilities totalling CN¥13.8b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Sinopharm Group has a huge market capitalization of CN¥68.3b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Sinopharm Group has net debt of just 1.1 times EBITDA, indicating that it is certainly not a reckless borrower. And this view is supported by the solid interest coverage, with EBIT coming in at 7.9 times the interest expense over the last year. The good news is that Sinopharm Group has increased its EBIT by 5.7% over twelve months, which should ease any concerns about debt repayment. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Sinopharm Group 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. In the last three years, Sinopharm Group's free cash flow amounted to 46% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

On this analysis, Sinopharm Group's net debt to EBITDA was a real positive, just like an unsolicited gift of cupcakes from a work colleague. And its apparent ability to to cover its interest expense with its EBIT is also rather rousing! It's also worth noting that Sinopharm Group is in the Healthcare industry, which is often considered to be quite defensive. All these things considered, it appears that Sinopharm Group can comfortably handle its current debt levels. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 2 warning signs we've spotted with Sinopharm Group (including 1 which is concerning) .

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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This article by Simply Wall St is general in nature. 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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