Sino Biopharmaceutical (HKG:1177) Seems To Use Debt Quite Sensibly

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Sino Biopharmaceutical Limited (HKG:1177) 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 is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. 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. 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.

See our latest analysis for Sino Biopharmaceutical

What Is Sino Biopharmaceutical's Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 Sino Biopharmaceutical had CN¥13.9b of debt, an increase on CN¥8.55b, over one year. But it also has CN¥15.5b in cash to offset that, meaning it has CN¥1.56b net cash.

How Healthy Is Sino Biopharmaceutical's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Sino Biopharmaceutical had liabilities of CN¥10.9b due within 12 months and liabilities of CN¥13.8b due beyond that. Offsetting these obligations, it had cash of CN¥15.5b as well as receivables valued at CN¥3.04b due within 12 months. So it has liabilities totalling CN¥6.28b more than its cash and near-term receivables, combined.

Given Sino Biopharmaceutical has a humongous market capitalization of CN¥132.2b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. 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.

On the other hand, Sino Biopharmaceutical's EBIT dived 17%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. 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 Sino Biopharmaceutical 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. 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. During the last three years, Sino Biopharmaceutical generated free cash flow amounting to a very robust 80% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Sino Biopharmaceutical has CN¥1.56b in net cash. And it impressed us with free cash flow of CN¥3.5b, being 80% of its EBIT. So we don't have any problem with Sino Biopharmaceutical's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. 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 1 warning sign for Sino Biopharmaceutical you should know about.

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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