Is Hua Medicine (Shanghai) (HKG:2552) Using Too Much Debt?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Hua Medicine (Shanghai) Ltd. (HKG:2552) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Hua Medicine (Shanghai)

How Much Debt Does Hua Medicine (Shanghai) Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2023 Hua Medicine (Shanghai) had CN¥162.7m of debt, an increase on none, over one year. But it also has CN¥881.3m in cash to offset that, meaning it has CN¥718.6m net cash.

A Look At Hua Medicine (Shanghai)'s Liabilities

According to the last reported balance sheet, Hua Medicine (Shanghai) had liabilities of CN¥256.5m due within 12 months, and liabilities of CN¥676.9m due beyond 12 months. Offsetting these obligations, it had cash of CN¥881.3m as well as receivables valued at CN¥25.6m due within 12 months. So it has liabilities totalling CN¥26.6m more than its cash and near-term receivables, combined.

Having regard to Hua Medicine (Shanghai)'s size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the CN¥1.70b company is short on cash, but still worth keeping an eye on the balance sheet. While it does have liabilities worth noting, Hua Medicine (Shanghai) also has more cash than debt, so we're pretty confident it can manage its debt safely. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Hua Medicine (Shanghai) 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.

In the last year Hua Medicine (Shanghai) managed to produce its first revenue as a listed company, but given the lack of profit, shareholders will no doubt be hoping to see some strong increases.

So How Risky Is Hua Medicine (Shanghai)?

While Hua Medicine (Shanghai) lost money on an earnings before interest and tax (EBIT) level, it actually generated positive free cash flow CN¥115m. So taking that on face value, and considering the net cash situation, we don't think that the stock is too risky in the near term. Until we see some positive EBIT, we're a bit cautious of the stock, not least because of the rather modest revenue growth. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Hua Medicine (Shanghai) has 2 warning signs we think you should be aware of.

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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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.