Here's Why CSPC Pharmaceutical Group (HKG:1093) Can Manage Its Debt Responsibly

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.' 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 CSPC Pharmaceutical Group Limited (HKG:1093) does use debt in its business. But the more important question is: how much risk is that debt creating?

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. If things get really bad, the lenders can take control of the business. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for CSPC Pharmaceutical Group

What Is CSPC Pharmaceutical Group's Debt?

The image below, which you can click on for greater detail, shows that at December 2023 CSPC Pharmaceutical Group had debt of CN¥706.9m, up from CN¥582.5m in one year. However, it does have CN¥13.8b in cash offsetting this, leading to net cash of CN¥13.1b.

How Healthy Is CSPC Pharmaceutical Group's Balance Sheet?

We can see from the most recent balance sheet that CSPC Pharmaceutical Group had liabilities of CN¥10.2b falling due within a year, and liabilities of CN¥1.08b due beyond that. Offsetting this, it had CN¥13.8b in cash and CN¥9.84b in receivables that were due within 12 months. So it can boast CN¥12.3b more liquid assets than total liabilities.

This surplus suggests that CSPC Pharmaceutical Group is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Succinctly put, CSPC Pharmaceutical Group boasts net cash, so it's fair to say it does not have a heavy debt load!

Fortunately, CSPC Pharmaceutical Group grew its EBIT by 8.9% in the last year, making that debt load look even more manageable. 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 CSPC Pharmaceutical Group can strengthen its balance sheet over time. 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 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. In the last three years, CSPC Pharmaceutical Group's free cash flow amounted to 45% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case CSPC Pharmaceutical Group has CN¥13.1b in net cash and a decent-looking balance sheet. On top of that, it increased its EBIT by 8.9% in the last twelve months. So we don't think CSPC Pharmaceutical Group'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. For instance, we've identified 1 warning sign for CSPC Pharmaceutical Group that you should be aware of.

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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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.

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