Sinco Pharmaceuticals Holdings (HKG:6833) Could Easily Take On More Debt

Warren Buffett famously said, '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. As with many other companies Sinco Pharmaceuticals Holdings Limited (HKG:6833) makes use of debt. But is this debt a concern to shareholders?

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. 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 think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Sinco Pharmaceuticals Holdings

What Is Sinco Pharmaceuticals Holdings's Net Debt?

As you can see below, Sinco Pharmaceuticals Holdings had CN¥81.0m of debt at December 2020, down from CN¥187.5m a year prior. However, its balance sheet shows it holds CN¥149.0m in cash, so it actually has CN¥68.0m net cash.

How Strong Is Sinco Pharmaceuticals Holdings' Balance Sheet?

The latest balance sheet data shows that Sinco Pharmaceuticals Holdings had liabilities of CN¥990.8m due within a year, and liabilities of CN¥96.8m falling due after that. Offsetting these obligations, it had cash of CN¥149.0m as well as receivables valued at CN¥587.2m due within 12 months. So it has liabilities totalling CN¥351.4m more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Sinco Pharmaceuticals Holdings has a market capitalization of CN¥799.1m, 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. While it does have liabilities worth noting, Sinco Pharmaceuticals Holdings also has more cash than debt, so we're pretty confident it can manage its debt safely.

Better yet, Sinco Pharmaceuticals Holdings grew its EBIT by 147% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. There's no doubt that we learn most about debt from the balance sheet. But it is Sinco Pharmaceuticals Holdings's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Sinco Pharmaceuticals Holdings may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the most recent two years, Sinco Pharmaceuticals Holdings recorded free cash flow worth 63% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While Sinco Pharmaceuticals Holdings does have more liabilities than liquid assets, it also has net cash of CN¥68.0m. And we liked the look of last year's 147% year-on-year EBIT growth. So is Sinco Pharmaceuticals Holdings's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example - Sinco Pharmaceuticals Holdings has 2 warning signs we think you should be aware of.

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.

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