Sinco Pharmaceuticals Holdings (HKG:6833) Has A Pretty Healthy Balance Sheet

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 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. We note that Sinco Pharmaceuticals Holdings Limited (HKG:6833) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. 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.

Check out our latest analysis for Sinco Pharmaceuticals Holdings

What Is Sinco Pharmaceuticals Holdings's Debt?

The chart below, which you can click on for greater detail, shows that Sinco Pharmaceuticals Holdings had CN¥332.8m in debt in June 2022; about the same as the year before. However, its balance sheet shows it holds CN¥456.7m in cash, so it actually has CN¥123.9m net cash.

How Healthy Is Sinco Pharmaceuticals Holdings' Balance Sheet?

The latest balance sheet data shows that Sinco Pharmaceuticals Holdings had liabilities of CN¥847.7m due within a year, and liabilities of CN¥159.4m falling due after that. Offsetting this, it had CN¥456.7m in cash and CN¥254.0m in receivables that were due within 12 months. So its liabilities total CN¥296.4m more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of CN¥445.3m, so it does suggest shareholders should keep an eye on Sinco Pharmaceuticals Holdings' use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. Despite its noteworthy liabilities, Sinco Pharmaceuticals Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact Sinco Pharmaceuticals Holdings's saving grace is its low debt levels, because its EBIT has tanked 24% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Sinco Pharmaceuticals Holdings will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. 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 three years, Sinco Pharmaceuticals Holdings recorded free cash flow worth 78% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

Although Sinco Pharmaceuticals Holdings's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥123.9m. The cherry on top was that in converted 78% of that EBIT to free cash flow, bringing in CN¥268m. So we are not troubled with Sinco Pharmaceuticals Holdings's debt use. 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. For example Sinco Pharmaceuticals Holdings has 3 warning signs (and 1 which is potentially serious) we think you should know about.

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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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.