These 4 Measures Indicate That China Pioneer Pharma Holdings (HKG:1345) Is Using Debt Safely

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that China Pioneer Pharma Holdings Limited (HKG:1345) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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 China Pioneer Pharma Holdings

What Is China Pioneer Pharma Holdings's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2021 China Pioneer Pharma Holdings had CN¥89.1m of debt, an increase on CN¥44.4m, over one year. However, it does have CN¥292.5m in cash offsetting this, leading to net cash of CN¥203.5m.

How Strong Is China Pioneer Pharma Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that China Pioneer Pharma Holdings had liabilities of CN¥215.4m due within 12 months and liabilities of CN¥32.3m due beyond that. On the other hand, it had cash of CN¥292.5m and CN¥302.7m worth of receivables due within a year. So it actually has CN¥347.7m more liquid assets than total liabilities.

This surplus suggests that China Pioneer Pharma Holdings is using debt in a way that is appears to be both safe and conservative. Due to its strong net asset position, it is not likely to face issues with its lenders. Simply put, the fact that China Pioneer Pharma Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.

And we also note warmly that China Pioneer Pharma Holdings grew its EBIT by 16% last year, making its debt load easier to handle. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since China Pioneer Pharma Holdings 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 company can only pay off debt with cold hard cash, not accounting profits. While China Pioneer Pharma Holdings 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. Over the last three years, China Pioneer Pharma Holdings actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

While it is always sensible to investigate a company's debt, in this case China Pioneer Pharma Holdings has CN¥203.5m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 109% of that EBIT to free cash flow, bringing in CN¥167m. The bottom line is that we do not find China Pioneer Pharma Holdings's debt levels at all concerning. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that China Pioneer Pharma Holdings is showing 3 warning signs in our investment analysis , and 1 of those makes us a bit uncomfortable...

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.

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.

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