These 4 Measures Indicate That 3SBio (HKG:1530) Is Using Debt Safely

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. Importantly, 3SBio Inc. (HKG:1530) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for 3SBio

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 on the other hand it also has CN¥6.67b in cash, leading to a CN¥1.74b net cash position.

How Strong Is 3SBio's Balance Sheet?

According to the last reported balance sheet, 3SBio had liabilities of CN¥3.56b due within 12 months, and liabilities of CN¥3.65b due beyond 12 months. Offsetting these obligations, it had cash of CN¥6.67b as well as receivables valued at CN¥1.34b due within 12 months. So it can boast 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. Simply put, the fact that 3SBio has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, 3SBio grew its EBIT by 40% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 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. In the last three years, 3SBio's free cash flow amounted to 46% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

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 40% year-on-year EBIT growth. So we don't think 3SBio's use of debt is risky. Over time, share prices tend to follow earnings per share, so if you're interested in 3SBio, you may well want to click here to check an interactive graph of its earnings per share history.

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.

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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.