Fusen Pharmaceutical (HKG:1652) Seems To Use Debt Quite Sensibly

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. We note that Fusen Pharmaceutical Company Limited (HKG:1652) does have debt on its balance sheet. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Fusen Pharmaceutical

What Is Fusen Pharmaceutical's Net Debt?

As you can see below, Fusen Pharmaceutical had CN¥198.5m of debt at December 2020, down from CN¥210.0m a year prior. But on the other hand it also has CN¥312.5m in cash, leading to a CN¥114.0m net cash position.

How Healthy Is Fusen Pharmaceutical's Balance Sheet?

We can see from the most recent balance sheet that Fusen Pharmaceutical had liabilities of CN¥547.6m falling due within a year, and liabilities of CN¥35.5m due beyond that. On the other hand, it had cash of CN¥312.5m and CN¥183.9m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥86.6m.

Since publicly traded Fusen Pharmaceutical shares are worth a total of CN¥3.15b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Fusen Pharmaceutical boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Fusen Pharmaceutical grew its EBIT by 75% over the last twelve months, and that growth will make it easier to handle its debt. 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, a company can only pay off debt with cold hard cash, not accounting profits. Fusen Pharmaceutical 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. During the last three years, Fusen Pharmaceutical burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

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¥114.0m. And it impressed us with its EBIT growth of 75% over the last year. So we are not troubled with Fusen Pharmaceutical's debt use. 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. Case in point: We've spotted 3 warning signs for Fusen Pharmaceutical you should be aware of, and 1 of them is a bit unpleasant.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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