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 can see that China NT Pharma Group Company Limited (HKG:1011) does use debt in its business. But the more important question is: how much risk is that debt creating?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
What Is China NT Pharma Group's Debt?
As you can see below, China NT Pharma Group had CN¥750.1m of debt at December 2021, down from CN¥841.9m a year prior. And it doesn't have much cash, so its net debt is about the same.
How Healthy Is China NT Pharma Group's Balance Sheet?
We can see from the most recent balance sheet that China NT Pharma Group had liabilities of CN¥989.1m falling due within a year, and liabilities of CN¥92.5m due beyond that. Offsetting this, it had CN¥9.44m in cash and CN¥90.4m in receivables that were due within 12 months. So its liabilities total CN¥981.8m more than the combination of its cash and short-term receivables.
The deficiency here weighs heavily on the CN¥126.8m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. After all, China NT Pharma Group would likely require a major re-capitalisation if it had to pay its creditors today. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since China NT Pharma Group will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Over 12 months, China NT Pharma Group reported revenue of CN¥227m, which is a gain of 2.2%, although it did not report any earnings before interest and tax. We usually like to see faster growth from unprofitable companies, but each to their own.
Over the last twelve months China NT Pharma Group produced an earnings before interest and tax (EBIT) loss. Indeed, it lost a very considerable CN¥80m at the EBIT level. Reflecting on this and the significant total liabilities, it's hard to know what to say about the stock because of our intense dis-affinity for it. Like every long-shot we're sure it has a glossy presentation outlining its blue-sky potential. But the reality is that it is low on liquid assets relative to liabilities, and it lost CN¥542k in the last year. So we're not very excited about owning this stock. Its too risky for us. 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, we've discovered 2 warning signs for China NT Pharma Group (1 is concerning!) that you should be aware of before investing here.
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.
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.