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

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Shanghai Henlius Biotech, Inc. (HKG:2696) does carry debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

Check out our latest analysis for Shanghai Henlius Biotech

What Is Shanghai Henlius Biotech's Net Debt?

As you can see below, at the end of June 2023, Shanghai Henlius Biotech had CN¥3.69b of debt, up from CN¥3.27b a year ago. Click the image for more detail. However, because it has a cash reserve of CN¥784.4m, its net debt is less, at about CN¥2.90b.

A Look At Shanghai Henlius Biotech's Liabilities

According to the last reported balance sheet, Shanghai Henlius Biotech had liabilities of CN¥4.95b due within 12 months, and liabilities of CN¥2.75b due beyond 12 months. On the other hand, it had cash of CN¥784.4m and CN¥864.8m worth of receivables due within a year. So its liabilities total CN¥6.05b more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of CN¥5.70b, we think shareholders really should watch Shanghai Henlius Biotech's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. When analysing debt levels, the balance sheet is the obvious place to start. 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 want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

In the last year Shanghai Henlius Biotech wasn't profitable at an EBIT level, but managed to grow its revenue by 89%, to CN¥4.4b. Shareholders probably have their fingers crossed that it can grow its way to profits.

Caveat Emptor

While we can certainly appreciate Shanghai Henlius Biotech's revenue growth, its earnings before interest and tax (EBIT) loss is not ideal. Indeed, it lost CN¥55m at the EBIT level. When we look at that alongside the significant liabilities, we're not particularly confident about the company. It would need to improve its operations quickly for us to be interested in it. Not least because it burned through CN¥384m in negative free cash flow over the last year. That means it's on the risky side of things. For riskier companies like Shanghai Henlius Biotech I always like to keep an eye on the long term profit and revenue trends. Fortunately, you can click to see our interactive graph of its profit, revenue, and operating cashflow.

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.