Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 can see that CSPC Pharmaceutical Group Limited (HKG:1093) does use debt in its business. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is CSPC Pharmaceutical Group's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of December 2020 CSPC Pharmaceutical Group had CN¥112.2m of debt, an increase on CN¥33.9m, over one year. But it also has CN¥9.28b in cash to offset that, meaning it has CN¥9.17b net cash.
How Strong Is CSPC Pharmaceutical Group's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that CSPC Pharmaceutical Group had liabilities of CN¥6.30b due within 12 months and liabilities of CN¥667.3m due beyond that. On the other hand, it had cash of CN¥9.28b and CN¥4.74b worth of receivables due within a year. So it actually has CN¥7.05b more liquid assets than total liabilities.
This short term liquidity is a sign that CSPC Pharmaceutical Group could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that CSPC Pharmaceutical Group has more cash than debt is arguably a good indication that it can manage its debt safely.
Also positive, CSPC Pharmaceutical Group grew its EBIT by 20% in the last year, and that should make it easier to pay down debt, going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine CSPC Pharmaceutical Group'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.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While CSPC Pharmaceutical Group 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. Looking at the most recent three years, CSPC Pharmaceutical Group recorded free cash flow of 27% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.
While it is always sensible to investigate a company's debt, in this case CSPC Pharmaceutical Group has CN¥9.17b in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 20% over the last year. So we don't think CSPC Pharmaceutical Group's use of debt is risky. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that CSPC Pharmaceutical Group insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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