Hansoh Pharmaceutical Group (HKG:3692) Has A Rock Solid Balance Sheet

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.' 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. We can see that Hansoh Pharmaceutical Group Company Limited (HKG:3692) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Hansoh Pharmaceutical Group

What Is Hansoh Pharmaceutical Group's Net Debt?

As you can see below, at the end of June 2022, Hansoh Pharmaceutical Group had CN¥4.03b of debt, up from CN¥3.79b a year ago. Click the image for more detail. But on the other hand it also has CN¥20.9b in cash, leading to a CN¥16.9b net cash position.

How Healthy Is Hansoh Pharmaceutical Group's Balance Sheet?

We can see from the most recent balance sheet that Hansoh Pharmaceutical Group had liabilities of CN¥3.21b falling due within a year, and liabilities of CN¥4.51b due beyond that. Offsetting these obligations, it had cash of CN¥20.9b as well as receivables valued at CN¥3.03b due within 12 months. So it can boast CN¥16.3b more liquid assets than total liabilities.

This surplus suggests that Hansoh Pharmaceutical Group is using debt in a way that is appears to be both safe and conservative. Due to its strong net asset position, it is not likely to face issues with its lenders. Simply put, the fact that Hansoh Pharmaceutical Group has more cash than debt is arguably a good indication that it can manage its debt safely.

On the other hand, Hansoh Pharmaceutical Group saw its EBIT drop by 2.3% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder 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 Hansoh 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Hansoh Pharmaceutical Group may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, Hansoh Pharmaceutical Group produced sturdy free cash flow equating to 75% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While it is always sensible to investigate a company's debt, in this case Hansoh Pharmaceutical Group has CN¥16.9b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥2.8b, being 75% of its EBIT. So we don't think Hansoh Pharmaceutical Group's use of debt is risky. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Hansoh Pharmaceutical Group's earnings per share history for free.

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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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.