We Think 3SBio (HKG:1530) Can Manage Its Debt With Ease

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. Importantly, 3SBio Inc. (HKG:1530) does carry debt. But is this debt a concern to shareholders?

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 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. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for 3SBio

How Much Debt Does 3SBio Carry?

You can click the graphic below for the historical numbers, but it shows that 3SBio had CN¥2.59b of debt in December 2021, down from CN¥2.87b, one year before. However, its balance sheet shows it holds CN¥4.77b in cash, so it actually has CN¥2.18b net cash.

A Look At 3SBio's Liabilities

The latest balance sheet data shows that 3SBio had liabilities of CN¥1.42b due within a year, and liabilities of CN¥3.13b falling due after that. Offsetting these obligations, it had cash of CN¥4.77b as well as receivables valued at CN¥1.38b due within 12 months. So it actually has CN¥1.59b 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.

Also positive, 3SBio grew its EBIT by 22% in the last year, and that should make it easier to pay down debt, going forward. 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're focused on the future you can check out this free report showing analyst profit forecasts.

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. Over the most recent three years, 3SBio recorded free cash flow worth 51% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that 3SBio has net cash of CN¥2.18b, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 22% over the last year. So we don't think 3SBio's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 1 warning sign for 3SBio that you should be aware of.

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.