Is Shanghai Henlius Biotech (HKG:2696) Using Too Much Debt?

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. Importantly, Shanghai Henlius Biotech, Inc. (HKG:2696) does carry debt. But the real question is whether this debt is making the company risky.

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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Shanghai Henlius Biotech

What Is Shanghai Henlius Biotech's Debt?

The image below, which you can click on for greater detail, shows that at June 2022 Shanghai Henlius Biotech had debt of CN¥3.27b, up from CN¥2.30b in one year. However, it also had CN¥794.7m in cash, and so its net debt is CN¥2.48b.

A Look At Shanghai Henlius Biotech's Liabilities

Zooming in on the latest balance sheet data, we can see that Shanghai Henlius Biotech had liabilities of CN¥4.23b due within 12 months and liabilities of CN¥1.88b due beyond that. On the other hand, it had cash of CN¥794.7m and CN¥554.0m worth of receivables due within a year. So its liabilities total CN¥4.76b more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of CN¥6.59b, so it does suggest shareholders should keep an eye on Shanghai Henlius Biotech's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Shanghai Henlius Biotech's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

In the last year Shanghai Henlius Biotech wasn't profitable at an EBIT level, but managed to grow its revenue by 111%, to CN¥2.3b. So its pretty obvious shareholders are hoping for more growth!

Caveat Emptor

Despite the top line growth, Shanghai Henlius Biotech still had an earnings before interest and tax (EBIT) loss over the last year. To be specific the EBIT loss came in at CN¥401m. 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¥1.0b of cash over the last year. So in short it's a really risky stock. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 2 warning signs we've spotted with Shanghai Henlius Biotech .

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.