Here's Why Sino Biopharmaceutical (HKG:1177) 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 Sino Biopharmaceutical Limited (HKG:1177) does use debt in its business. But the real question is whether this debt is making the company risky.

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Sino Biopharmaceutical

What Is Sino Biopharmaceutical's Debt?

The image below, which you can click on for greater detail, shows that Sino Biopharmaceutical had debt of CN¥12.3b at the end of December 2023, a reduction from CN¥13.7b over a year. However, it does have CN¥14.1b in cash offsetting this, leading to net cash of CN¥1.77b.

A Look At Sino Biopharmaceutical's Liabilities

Zooming in on the latest balance sheet data, we can see that Sino Biopharmaceutical had liabilities of CN¥22.6b due within 12 months and liabilities of CN¥2.83b due beyond that. Offsetting this, it had CN¥14.1b in cash and CN¥6.20b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥5.12b.

Of course, Sino Biopharmaceutical has a market capitalization of CN¥53.2b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Sino Biopharmaceutical also has more cash than debt, so we're pretty confident it can manage its debt safely.

Sino Biopharmaceutical's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Sino Biopharmaceutical'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Sino Biopharmaceutical 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, Sino Biopharmaceutical recorded free cash flow worth a fulsome 83% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Sino Biopharmaceutical has CN¥1.77b in net cash. And it impressed us with free cash flow of CN¥4.6b, being 83% of its EBIT. So we don't think Sino Biopharmaceutical's use of debt is risky. We'd be motivated to research the stock further if we found out that Sino Biopharmaceutical insiders have bought shares recently. If you would too, then you're in luck, since today we're sharing our list of reported insider transactions for free.

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.

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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.