Is Sinopharm Group (HKG:1099) A Risky Investment?

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.' 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, Sinopharm Group Co. Ltd. (HKG:1099) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. 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. 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 Sinopharm Group

What Is Sinopharm Group's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2023 Sinopharm Group had debt of CN¥85.4b, up from CN¥72.6b in one year. However, because it has a cash reserve of CN¥44.3b, its net debt is less, at about CN¥41.1b.

A Look At Sinopharm Group's Liabilities

We can see from the most recent balance sheet that Sinopharm Group had liabilities of CN¥278.8b falling due within a year, and liabilities of CN¥25.3b due beyond that. Offsetting these obligations, it had cash of CN¥44.3b as well as receivables valued at CN¥250.7b due within 12 months. So it has liabilities totalling CN¥9.05b more than its cash and near-term receivables, combined.

Given Sinopharm Group has a market capitalization of CN¥59.0b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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

With a debt to EBITDA ratio of 1.7, Sinopharm Group uses debt artfully but responsibly. And the fact that its trailing twelve months of EBIT was 9.0 times its interest expenses harmonizes with that theme. Fortunately, Sinopharm Group grew its EBIT by 4.7% in the last year, making that debt load look even more manageable. 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 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Looking at the most recent three years, Sinopharm Group recorded free cash flow of 33% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

On our analysis Sinopharm Group's interest cover should signal that it won't have too much trouble with its debt. But the other factors we noted above weren't so encouraging. For example, its conversion of EBIT to free cash flow makes us a little nervous about its debt. It's also worth noting that Sinopharm Group is in the Healthcare industry, which is often considered to be quite defensive. When we consider all the elements mentioned above, it seems to us that Sinopharm Group is managing its debt quite well. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. Given Sinopharm Group has a strong balance sheet is profitable and pays a dividend, it would be good to know how fast its dividends are growing, if at all. You can find out instantly by clicking this link.

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. 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.