Is Guangzhou Baiyunshan Pharmaceutical Holdings (HKG:874) A Risky Investment?

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.' 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 note that Guangzhou Baiyunshan Pharmaceutical Holdings Company Limited (HKG:874) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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 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?

As you can see below, at the end of March 2023, Guangzhou Baiyunshan Pharmaceutical Holdings had CN¥12.4b of debt, up from CN¥10.7b a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥20.3b in cash, so it actually has CN¥7.86b net cash.

A Look At Guangzhou Baiyunshan Pharmaceutical Holdings' Liabilities

Zooming in on the latest balance sheet data, we can see that Guangzhou Baiyunshan Pharmaceutical Holdings had liabilities of CN¥32.9b due within 12 months and liabilities of CN¥5.17b due beyond that. Offsetting these obligations, it had cash of CN¥20.3b as well as receivables valued at CN¥23.0b due within 12 months. So it actually has CN¥5.29b 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.

Guangzhou Baiyunshan Pharmaceutical Holdings's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of debt. 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 Guangzhou Baiyunshan Pharmaceutical Holdings can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Guangzhou Baiyunshan Pharmaceutical 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 last three years, Guangzhou Baiyunshan Pharmaceutical Holdings recorded free cash flow worth a fulsome 88% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Guangzhou Baiyunshan Pharmaceutical Holdings has net cash of CN¥7.86b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥1.9b, being 88% of its EBIT. So we don't think Guangzhou Baiyunshan Pharmaceutical Holdings's use of debt is risky. 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. Be aware that Guangzhou Baiyunshan Pharmaceutical Holdings is showing 2 warning signs in our investment analysis , and 1 of those is concerning...

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.