Is YiChang HEC ChangJiang Pharmaceutical (HKG:1558) A Risky Investment?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. Importantly, YiChang HEC ChangJiang Pharmaceutical Co., Ltd. (HKG:1558) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for YiChang HEC ChangJiang Pharmaceutical

How Much Debt Does YiChang HEC ChangJiang Pharmaceutical Carry?

You can click the graphic below for the historical numbers, but it shows that as of December 2021 YiChang HEC ChangJiang Pharmaceutical had CN¥3.19b of debt, an increase on CN¥3.01b, over one year. On the flip side, it has CN¥1.13b in cash leading to net debt of about CN¥2.06b.

How Healthy Is YiChang HEC ChangJiang Pharmaceutical's Balance Sheet?

According to the last reported balance sheet, YiChang HEC ChangJiang Pharmaceutical had liabilities of CN¥1.24b due within 12 months, and liabilities of CN¥3.28b due beyond 12 months. Offsetting these obligations, it had cash of CN¥1.13b as well as receivables valued at CN¥546.8m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥2.84b.

This is a mountain of leverage relative to its market capitalization of CN¥3.91b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if YiChang HEC ChangJiang Pharmaceutical can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Over 12 months, YiChang HEC ChangJiang Pharmaceutical made a loss at the EBIT level, and saw its revenue drop to CN¥914m, which is a fall of 61%. To be frank that doesn't bode well.

Caveat Emptor

While YiChang HEC ChangJiang Pharmaceutical's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Its EBIT loss was a whopping CN¥423m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. However, it doesn't help that it burned through CN¥1.2b of cash over the last year. So suffice it to say we consider the stock very risky. 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. For example, we've discovered 1 warning sign for YiChang HEC ChangJiang Pharmaceutical that you should be aware of before investing here.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.