Is Sino Biopharmaceutical (HKG:1177) Using Too Much Debt?

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. Importantly, Sino Biopharmaceutical Limited (HKG:1177) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. 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. 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.

Check out our latest analysis for Sino Biopharmaceutical

How Much Debt Does Sino Biopharmaceutical Carry?

You can click the graphic below for the historical numbers, but it shows that Sino Biopharmaceutical had CN¥11.7b of debt in December 2021, down from CN¥13.9b, one year before. But it also has CN¥15.2b in cash to offset that, meaning it has CN¥3.49b net cash.

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¥15.3b due within 12 months and liabilities of CN¥7.47b due beyond that. Offsetting this, it had CN¥15.2b in cash and CN¥4.63b in receivables that were due within 12 months. So it has liabilities totalling CN¥2.96b more than its cash and near-term receivables, combined.

Since publicly traded Sino Biopharmaceutical shares are worth a total of CN¥61.0b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. 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.

The good news is that Sino Biopharmaceutical has increased its EBIT by 2.0% over twelve months, which should ease any concerns about debt repayment. 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 Sino Biopharmaceutical 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Sino Biopharmaceutical may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, Sino Biopharmaceutical produced sturdy free cash flow equating to 54% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Sino Biopharmaceutical has CN¥3.49b in net cash. So we don't have any problem with Sino Biopharmaceutical's use of debt. 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. Case in point: We've spotted 2 warning signs for Sino Biopharmaceutical you should be aware of, and 1 of them is concerning.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.