These 4 Measures Indicate That Hansoh Pharmaceutical Group (HKG:3692) Is Using Debt Reasonably Well

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. 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?

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at 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 2022 Hansoh Pharmaceutical Group had debt of CN¥4.28b, up from CN¥3.74b in one year. But it also has CN¥21.6b in cash to offset that, meaning it has CN¥17.3b 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¥2.62b due within 12 months and liabilities of CN¥4.74b due beyond that. Offsetting this, it had CN¥21.6b in cash and CN¥3.63b in receivables that were due within 12 months. So it actually has CN¥17.9b 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. Succinctly put, Hansoh Pharmaceutical Group boasts net cash, so it's fair to say it does not have a heavy debt load!

But the other side of the story is that Hansoh Pharmaceutical Group saw its EBIT decline by 7.6% over the last year. 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're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. 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 67% 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 Hansoh Pharmaceutical Group has net cash of CN¥17.3b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥2.4b, being 67% of its EBIT. So is Hansoh Pharmaceutical Group's debt a risk? It doesn't seem so to us. Over time, share prices tend to follow earnings per share, so if you're interested in Hansoh Pharmaceutical Group, you may well want to click here to check an interactive graph of its earnings per share history.

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.