Is CSPC Pharmaceutical Group (HKG:1093) 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.' 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. Importantly, CSPC Pharmaceutical Group Limited (HKG:1093) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for CSPC Pharmaceutical Group

What Is CSPC Pharmaceutical Group's Debt?

As you can see below, CSPC Pharmaceutical Group had CN¥75.3m of debt at June 2023, down from CN¥396.4m a year prior. However, it does have CN¥12.8b in cash offsetting this, leading to net cash of CN¥12.7b.

A Look At CSPC Pharmaceutical Group's Liabilities

Zooming in on the latest balance sheet data, we can see that CSPC Pharmaceutical Group had liabilities of CN¥9.03b due within 12 months and liabilities of CN¥1.14b due beyond that. Offsetting this, it had CN¥12.8b in cash and CN¥8.88b in receivables that were due within 12 months. So it can boast CN¥11.5b 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 2.1% in the last year, making that debt load look even more manageable. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if CSPC Pharmaceutical Group 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.

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. Over the most recent three years, CSPC Pharmaceutical Group recorded free cash flow worth 61% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that CSPC Pharmaceutical Group has net cash of CN¥12.7b, as well as more liquid assets than liabilities. So is CSPC Pharmaceutical Group's debt a risk? It doesn't seem so to us. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for CSPC Pharmaceutical Group (of which 1 can't be ignored!) you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.