Is Hansoh Pharmaceutical Group (HKG:3692) A Risky Investment?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. As with many other companies Hansoh Pharmaceutical Group Company Limited (HKG:3692) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Hansoh Pharmaceutical Group

What Is Hansoh Pharmaceutical Group's Net Debt?

The image below, which you can click on for greater detail, shows that at December 2021 Hansoh Pharmaceutical Group had debt of CN¥3.74b, up from none in one year. But on the other hand it also has CN¥18.9b in cash, leading to a CN¥15.2b net cash position.

How Healthy 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¥3.02b due within 12 months and liabilities of CN¥4.11b due beyond that. On the other hand, it had cash of CN¥18.9b and CN¥3.68b worth of receivables due within a year. So it can boast CN¥15.5b more liquid assets than total liabilities.

This excess liquidity suggests that Hansoh Pharmaceutical Group is taking a careful approach to debt. Given it has easily adequate short term liquidity, we don't think it will have any 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.

The good news is that Hansoh Pharmaceutical Group has increased its EBIT by 4.5% over twelve months, which should ease any concerns about debt repayment. When analysing debt levels, the balance sheet is the obvious place to start. 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're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 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. In the last three years, Hansoh Pharmaceutical Group's free cash flow amounted to 44% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While it is always sensible to investigate a company's debt, in this case Hansoh Pharmaceutical Group has CN¥15.2b in net cash and a decent-looking balance sheet. And it also grew its EBIT by 4.5% over the last year. So we don't think Hansoh Pharmaceutical Group's use of debt is risky. 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. For example, we've discovered 1 warning sign for Hansoh Pharmaceutical Group that you should be aware of before investing here.

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.