Does Guangzhou Baiyunshan Pharmaceutical Holdings (HKG:874) Have A Healthy Balance Sheet?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. As with many other companies Guangzhou Baiyunshan Pharmaceutical Holdings Company Limited (HKG:874) makes use of debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Guangzhou Baiyunshan Pharmaceutical Holdings

How Much Debt Does Guangzhou Baiyunshan Pharmaceutical Holdings Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2023 Guangzhou Baiyunshan Pharmaceutical Holdings had CN¥11.6b of debt, an increase on CN¥10.8b, over one year. But on the other hand it also has CN¥19.9b in cash, leading to a CN¥8.28b net cash position.

How Healthy Is Guangzhou Baiyunshan Pharmaceutical Holdings' Balance Sheet?

According to the last reported balance sheet, Guangzhou Baiyunshan Pharmaceutical Holdings had liabilities of CN¥32.7b due within 12 months, and liabilities of CN¥5.29b due beyond 12 months. Offsetting this, it had CN¥19.9b in cash and CN¥21.2b in receivables that were due within 12 months. So it can boast CN¥3.12b more liquid assets than total liabilities.

This short term liquidity is a sign that Guangzhou Baiyunshan Pharmaceutical Holdings could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Guangzhou Baiyunshan Pharmaceutical Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.

But the other side of the story is that Guangzhou Baiyunshan Pharmaceutical Holdings saw its EBIT decline by 3.8% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Guangzhou Baiyunshan Pharmaceutical Holdings's ability to maintain a healthy balance sheet going forward. 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. While Guangzhou Baiyunshan Pharmaceutical 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, Guangzhou Baiyunshan Pharmaceutical Holdings recorded free cash flow worth a fulsome 82% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case Guangzhou Baiyunshan Pharmaceutical Holdings has CN¥8.28b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥3.0b, being 82% of its EBIT. So we don't think Guangzhou Baiyunshan Pharmaceutical Holdings's use of debt is risky. 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. Case in point: We've spotted 1 warning sign for Guangzhou Baiyunshan Pharmaceutical Holdings you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.