Consun Pharmaceutical Group (HKG:1681) Seems To Use Debt Rather Sparingly

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.' 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. Importantly, Consun Pharmaceutical Group Limited (HKG:1681) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Consun Pharmaceutical Group

How Much Debt Does Consun Pharmaceutical Group Carry?

As you can see below, Consun Pharmaceutical Group had CN¥549.4m of debt, at December 2020, which is about the same as the year before. You can click the chart for greater detail. However, it does have CN¥1.94b in cash offsetting this, leading to net cash of CN¥1.39b.

A Look At Consun Pharmaceutical Group's Liabilities

The latest balance sheet data shows that Consun Pharmaceutical Group had liabilities of CN¥1.33b due within a year, and liabilities of CN¥101.9m falling due after that. Offsetting this, it had CN¥1.94b in cash and CN¥458.4m in receivables that were due within 12 months. So it can boast CN¥964.9m more liquid assets than total liabilities.

This excess liquidity is a great indication that Consun Pharmaceutical Group's balance sheet is almost as strong as Fort Knox. With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Simply put, the fact that Consun Pharmaceutical Group has more cash than debt is arguably a good indication that it can manage its debt safely.

And we also note warmly that Consun Pharmaceutical Group grew its EBIT by 11% 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 ultimately the future profitability of the business will decide if Consun Pharmaceutical Group 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Consun Pharmaceutical Group 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. Looking at the most recent three years, Consun Pharmaceutical Group recorded free cash flow of 45% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Consun Pharmaceutical Group has net cash of CN¥1.39b, as well as more liquid assets than liabilities. On top of that, it increased its EBIT by 11% in the last twelve months. So we don't think Consun Pharmaceutical Group's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that Consun Pharmaceutical Group is showing 2 warning signs in our investment analysis , you should know about...

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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