Hansoh Pharmaceutical Group (HKG:3692) Seems To Use Debt Quite Sensibly

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 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 more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Hansoh Pharmaceutical Group

How Much Debt Does Hansoh Pharmaceutical Group Carry?

As you can see below, at the end of June 2023, Hansoh Pharmaceutical Group had CN¥4.46b of debt, up from CN¥4.03b a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥23.5b in cash, so it actually has CN¥19.1b net cash.

How Strong Is Hansoh Pharmaceutical Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Hansoh Pharmaceutical Group had liabilities of CN¥7.42b due within 12 months and liabilities of CN¥350.8m due beyond that. Offsetting these obligations, it had cash of CN¥23.5b as well as receivables valued at CN¥3.33b due within 12 months. So it can boast CN¥19.1b more liquid assets than total liabilities.

This excess liquidity suggests that Hansoh Pharmaceutical Group is taking a careful approach to debt. Due to its strong net asset position, it is not likely to face issues with its lenders. Succinctly put, Hansoh Pharmaceutical Group boasts net cash, so it's fair to say it does not have a heavy debt load!

On the other hand, Hansoh Pharmaceutical Group's EBIT dived 11%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. 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 Hansoh Pharmaceutical Group'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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Hansoh 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, Hansoh Pharmaceutical Group produced sturdy free cash flow equating to 68% 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 we empathize with investors who find debt concerning, you should keep in mind that Hansoh Pharmaceutical Group has net cash of CN¥19.1b, as well as more liquid assets than liabilities. The cherry on top was that in converted 68% of that EBIT to free cash flow, bringing in CN¥1.8b. So is Hansoh Pharmaceutical Group's debt a risk? It doesn't seem so to us. 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.