These 4 Measures Indicate That Sinopharm Group (HKG:1099) Is Using Debt Reasonably Well

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Sinopharm Group Co. Ltd. (HKG:1099) does use debt in its business. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Sinopharm Group

What Is Sinopharm Group's Debt?

As you can see below, Sinopharm Group had CN¥72.6b of debt, at September 2022, which is about the same as the year before. You can click the chart for greater detail. However, because it has a cash reserve of CN¥38.2b, its net debt is less, at about CN¥34.4b.

How Healthy Is Sinopharm Group's Balance Sheet?

The latest balance sheet data shows that Sinopharm Group had liabilities of CN¥260.1b due within a year, and liabilities of CN¥20.6b falling due after that. Offsetting this, it had CN¥38.2b in cash and CN¥232.0b in receivables that were due within 12 months. So its liabilities total CN¥10.4b more than the combination of its cash and short-term receivables.

Since publicly traded Sinopharm Group shares are worth a total of CN¥58.2b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

While Sinopharm Group's low debt to EBITDA ratio of 1.5 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 6.5 times last year does give us pause. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. The good news is that Sinopharm Group has increased its EBIT by 5.2% over twelve months, which should ease any concerns about debt repayment. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, Sinopharm Group's free cash flow amounted to 28% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

Based on what we've seen Sinopharm Group is not finding it easy, given its conversion of EBIT to free cash flow, but the other factors we considered give us cause to be optimistic. In particular, we thought its net debt to EBITDA was a positive. 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.