We Think China Shineway Pharmaceutical Group (HKG:2877) Can Manage Its Debt With Ease

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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies China Shineway Pharmaceutical Group Limited (HKG:2877) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for China Shineway Pharmaceutical Group

What Is China Shineway Pharmaceutical Group's Debt?

The image below, which you can click on for greater detail, shows that at June 2020 China Shineway Pharmaceutical Group had debt of CN¥609.8m, up from none in one year. But it also has CN¥4.08b in cash to offset that, meaning it has CN¥3.47b net cash.

How Strong Is China Shineway Pharmaceutical Group's Balance Sheet?

The latest balance sheet data shows that China Shineway Pharmaceutical Group had liabilities of CN¥1.37b due within a year, and liabilities of CN¥229.2m falling due after that. Offsetting this, it had CN¥4.08b in cash and CN¥620.9m in receivables that were due within 12 months. So it can boast CN¥3.11b more liquid assets than total liabilities.

This surplus strongly suggests that China Shineway Pharmaceutical Group has a rock-solid balance sheet (and the debt is of no concern whatsoever). On this basis we think its balance sheet is strong like a sleek panther or even a proud lion. Succinctly put, China Shineway Pharmaceutical Group boasts net cash, so it's fair to say it does not have a heavy debt load!

But the bad news is that China Shineway Pharmaceutical Group has seen its EBIT plunge 13% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if China Shineway 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While China Shineway 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. During the last three years, China Shineway Pharmaceutical Group produced sturdy free cash flow equating to 79% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that China Shineway Pharmaceutical Group has net cash of CN¥3.47b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥397m, being 79% of its EBIT. So is China Shineway Pharmaceutical Group's debt a risk? It doesn't seem so to us. 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. To that end, you should be aware of the 1 warning sign we've spotted with China Shineway Pharmaceutical Group .

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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