Zhongzhi Pharmaceutical Holdings (HKG:3737) Has A Pretty Healthy Balance Sheet

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Zhongzhi Pharmaceutical Holdings Limited (HKG:3737) 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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Zhongzhi Pharmaceutical Holdings

What Is Zhongzhi Pharmaceutical Holdings's Debt?

As you can see below, Zhongzhi Pharmaceutical Holdings had CN¥57.2m of debt at December 2021, down from CN¥78.9m a year prior. However, its balance sheet shows it holds CN¥257.8m in cash, so it actually has CN¥200.6m net cash.

How Healthy Is Zhongzhi Pharmaceutical Holdings' Balance Sheet?

The latest balance sheet data shows that Zhongzhi Pharmaceutical Holdings had liabilities of CN¥500.8m due within a year, and liabilities of CN¥122.1m falling due after that. On the other hand, it had cash of CN¥257.8m and CN¥307.4m worth of receivables due within a year. So it has liabilities totalling CN¥57.7m more than its cash and near-term receivables, combined.

Since publicly traded Zhongzhi Pharmaceutical Holdings shares are worth a total of CN¥700.0m, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Zhongzhi Pharmaceutical Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact Zhongzhi Pharmaceutical Holdings's saving grace is its low debt levels, because its EBIT has tanked 44% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Zhongzhi Pharmaceutical Holdings's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Zhongzhi Pharmaceutical Holdings 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, Zhongzhi Pharmaceutical Holdings created free cash flow amounting to 19% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Zhongzhi Pharmaceutical Holdings has CN¥200.6m in net cash. So we are not troubled with Zhongzhi Pharmaceutical Holdings's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 4 warning signs we've spotted with Zhongzhi Pharmaceutical Holdings .

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.