Does Fusen Pharmaceutical (HKG:1652) Have A Healthy Balance Sheet?

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 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. We note that Fusen Pharmaceutical Company Limited (HKG:1652) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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.

Check out our latest analysis for Fusen Pharmaceutical

How Much Debt Does Fusen Pharmaceutical Carry?

As you can see below, at the end of June 2020, Fusen Pharmaceutical had CN¥229.3m of debt, up from CN¥170.0m a year ago. Click the image for more detail. But on the other hand it also has CN¥402.6m in cash, leading to a CN¥173.3m net cash position.

How Strong Is Fusen Pharmaceutical's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Fusen Pharmaceutical had liabilities of CN¥511.9m due within 12 months and liabilities of CN¥36.9m due beyond that. Offsetting these obligations, it had cash of CN¥402.6m as well as receivables valued at CN¥133.6m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥12.6m.

This state of affairs indicates that Fusen Pharmaceutical's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the CN¥3.06b company is short on cash, but still worth keeping an eye on the balance sheet. While it does have liabilities worth noting, Fusen Pharmaceutical also has more cash than debt, so we're pretty confident it can manage its debt safely.

In fact Fusen Pharmaceutical's saving grace is its low debt levels, because its EBIT has tanked 40% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But it is Fusen Pharmaceutical's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Fusen Pharmaceutical 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 last three years, Fusen Pharmaceutical reported free cash flow worth 19% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing up

We could understand if investors are concerned about Fusen Pharmaceutical's liabilities, but we can be reassured by the fact it has has net cash of CN¥173.3m. So while Fusen Pharmaceutical does not have a great balance sheet, it's certainly not too bad. 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 instance, we've identified 3 warning signs for Fusen Pharmaceutical (1 doesn't sit too well with us) you should be aware of.

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. 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.
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