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

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that 3SBio Inc. (HKG:1530) does use debt in its business. But is this debt a concern to shareholders?

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. 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. 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.

Our analysis indicates that 1530 is potentially undervalued!

What Is 3SBio's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2022 3SBio had debt of CN¥3.80b, up from CN¥2.60b in one year. But it also has CN¥6.27b in cash to offset that, meaning it has CN¥2.47b net cash.

How Healthy Is 3SBio's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that 3SBio had liabilities of CN¥1.87b due within 12 months and liabilities of CN¥4.23b due beyond that. On the other hand, it had cash of CN¥6.27b and CN¥1.17b worth of receivables due within a year. So it actually has CN¥1.34b 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.

And we also note warmly that 3SBio grew its EBIT by 12% last year, making its debt load easier to handle. The balance sheet is clearly the area to focus on when you are analysing debt. 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 company can only pay off debt with cold hard cash, not accounting profits. While 3SBio 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. Over the most recent three years, 3SBio recorded free cash flow worth 58% 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¥2.47b, as well as more liquid assets than liabilities. And it also grew its EBIT by 12% 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. Case in point: We've spotted 2 warning signs for 3SBio you should be aware of, and 1 of them is a bit concerning.

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.