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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that 3SBio Inc. (HKG:1530) 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
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What Is 3SBio's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of June 2023 3SBio had CN¥4.94b of debt, an increase on CN¥3.80b, over one year. But it also has CN¥6.67b in cash to offset that, meaning it has CN¥1.74b net cash.
A Look At 3SBio's Liabilities
The latest balance sheet data shows that 3SBio had liabilities of CN¥3.56b due within a year, and liabilities of CN¥3.65b falling due after that. On the other hand, it had cash of CN¥6.67b and CN¥1.34b worth of receivables due within a year. So it actually has CN¥805.6m more liquid assets than total liabilities.
This short term liquidity is a sign that 3SBio could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, 3SBio boasts net cash, so it's fair to say it does not have a heavy debt load!
On top of that, 3SBio grew its EBIT by 42% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine 3SBio'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. 3SBio 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. Looking at the most recent three years, 3SBio recorded free cash flow of 45% of its EBIT, which is weaker 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 3SBio has CN¥1.74b in net cash and a decent-looking balance sheet. And we liked the look of last year's 42% year-on-year EBIT growth. So is 3SBio'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. For example, we've discovered 1 warning sign for 3SBio that you should be aware of before investing here.
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.
About SEHK:1530
3SBio
An investment holding company, develops, produces markets, and sells biopharmaceutical products in Mainland China and internationally.
Flawless balance sheet and undervalued.