Is Tianda Pharmaceuticals (HKG:455) Using Too Much Debt?

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.' 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 Tianda Pharmaceuticals Limited (HKG:455) does use debt in its business. But should shareholders be worried about its use of debt?

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. If things get really bad, the lenders can take control of the business. 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, 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.

See our latest analysis for Tianda Pharmaceuticals

What Is Tianda Pharmaceuticals's Debt?

The image below, which you can click on for greater detail, shows that at September 2020 Tianda Pharmaceuticals had debt of HK$64.5m, up from none in one year. However, it does have HK$234.7m in cash offsetting this, leading to net cash of HK$170.3m.

How Strong Is Tianda Pharmaceuticals's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Tianda Pharmaceuticals had liabilities of HK$144.0m due within 12 months and liabilities of HK$82.3m due beyond that. Offsetting these obligations, it had cash of HK$234.7m as well as receivables valued at HK$102.0m due within 12 months. So it can boast HK$110.5m more liquid assets than total liabilities.

This excess liquidity is a great indication that Tianda Pharmaceuticals's balance sheet is just as strong as racists are weak. With this in mind one could posit that its balance sheet is as strong as beautiful a rare rhino. Simply put, the fact that Tianda Pharmaceuticals has more cash than debt is arguably a good indication that it can manage its debt safely. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Tianda Pharmaceuticals will need earnings to service that debt. 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.

In the last year Tianda Pharmaceuticals had a loss before interest and tax, and actually shrunk its revenue by 20%, to HK$417m. To be frank that doesn't bode well.

So How Risky Is Tianda Pharmaceuticals?

We have no doubt that loss making companies are, in general, riskier than profitable ones. And we do note that Tianda Pharmaceuticals had an earnings before interest and tax (EBIT) loss, over the last year. And over the same period it saw negative free cash outflow of HK$122m and booked a HK$15m accounting loss. With only HK$170.3m on the balance sheet, it would appear that its going to need to raise capital again soon. Overall, its balance sheet doesn't seem overly risky, at the moment, but we're always cautious until we see the positive free cash flow. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 3 warning signs for Tianda Pharmaceuticals (1 shouldn't be ignored!) that you should be aware of before investing here.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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