We Think Guangzhou Baiyunshan Pharmaceutical Holdings (HKG:874) Can Manage Its Debt With Ease

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Guangzhou Baiyunshan Pharmaceutical Holdings Company Limited (HKG:874) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

View our latest analysis for Guangzhou Baiyunshan Pharmaceutical Holdings

What Is Guangzhou Baiyunshan Pharmaceutical Holdings's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2023 Guangzhou Baiyunshan Pharmaceutical Holdings had debt of CN¥12.4b, up from CN¥10.4b in one year. However, its balance sheet shows it holds CN¥22.2b in cash, so it actually has CN¥9.74b net cash.

A Look At Guangzhou Baiyunshan Pharmaceutical Holdings' Liabilities

We can see from the most recent balance sheet that Guangzhou Baiyunshan Pharmaceutical Holdings had liabilities of CN¥33.0b falling due within a year, and liabilities of CN¥5.18b due beyond that. Offsetting this, it had CN¥22.2b in cash and CN¥21.3b in receivables that were due within 12 months. So it actually has CN¥5.22b 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. Succinctly put, Guangzhou Baiyunshan Pharmaceutical Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

While Guangzhou Baiyunshan Pharmaceutical Holdings doesn't seem to have gained much on the EBIT line, at least earnings remain stable for now. When analysing debt levels, the balance sheet is the obvious place to start. 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 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. 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 92% 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 it is always sensible to investigate a company's debt, in this case Guangzhou Baiyunshan Pharmaceutical Holdings has CN¥9.74b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥3.0b, being 92% of its EBIT. So is Guangzhou Baiyunshan Pharmaceutical Holdings's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. We've identified 1 warning sign with Guangzhou Baiyunshan Pharmaceutical Holdings , and understanding them should be part of your investment process.

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.