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

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. 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?

What Risk Does Debt Bring?

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. 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, 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 examine debt levels, we first consider both cash and debt levels, 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 June 2023 Hansoh Pharmaceutical Group had debt of CN¥4.46b, up from CN¥4.03b in one year. 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?

We can see from the most recent balance sheet that Hansoh Pharmaceutical Group had liabilities of CN¥7.42b falling due within a year, 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 actually has CN¥19.1b more liquid assets than total liabilities.

This surplus liquidity suggests that Hansoh Pharmaceutical Group's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Succinctly put, Hansoh 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 Hansoh Pharmaceutical Group has seen its EBIT plunge 16% in the last twelve months. 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 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 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 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¥19.1b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥2.4b, 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.

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.