We Think 3SBio (HKG:1530) Can Stay On Top Of Its Debt

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that 3SBio Inc. (HKG:1530) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for 3SBio

How Much Debt Does 3SBio Carry?

As you can see below, 3SBio had CN¥4.17b of debt at June 2024, down from CN¥4.94b a year prior. But on the other hand it also has CN¥5.78b in cash, leading to a CN¥1.61b net cash position.

A Look At 3SBio's Liabilities

We can see from the most recent balance sheet that 3SBio had liabilities of CN¥5.35b falling due within a year, and liabilities of CN¥1.72b due beyond that. Offsetting these obligations, it had cash of CN¥5.78b as well as receivables valued at CN¥1.25b due within 12 months. So its total liabilities are just about perfectly matched by its shorter-term, liquid assets.

Having regard to 3SBio's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the CN¥12.9b company is short on cash, but still worth keeping an eye on the balance sheet. While it does have liabilities worth noting, 3SBio also has more cash than debt, so we're pretty confident it can manage its debt safely.

But the other side of the story is that 3SBio saw its EBIT decline by 9.1% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. 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, 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. 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 it is always sensible to look at a company's total liabilities, it is very reassuring that 3SBio has CN¥1.61b in net cash. So we don't have any problem with 3SBio's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that 3SBio is showing 1 warning sign in our investment analysis , you should know about...

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.