Does Sihuan Pharmaceutical Holdings Group (HKG:460) Have A Healthy Balance Sheet?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. Importantly, Sihuan Pharmaceutical Holdings Group Ltd. (HKG:460) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. 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 Sihuan Pharmaceutical Holdings Group

What Is Sihuan Pharmaceutical Holdings Group's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2020 Sihuan Pharmaceutical Holdings Group had debt of CN¥587.8m, up from CN¥19.0m in one year. However, it does have CN¥5.37b in cash offsetting this, leading to net cash of CN¥4.78b.

A Look At Sihuan Pharmaceutical Holdings Group's Liabilities

Zooming in on the latest balance sheet data, we can see that Sihuan Pharmaceutical Holdings Group had liabilities of CN¥3.79b due within 12 months and liabilities of CN¥381.6m due beyond that. Offsetting these obligations, it had cash of CN¥5.37b as well as receivables valued at CN¥570.1m due within 12 months. So it can boast CN¥1.76b more liquid assets than total liabilities.

This surplus suggests that Sihuan Pharmaceutical Holdings Group is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Succinctly put, Sihuan Pharmaceutical Holdings Group boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that Sihuan Pharmaceutical Holdings Group's load is not too heavy, because its EBIT was down 71% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Sihuan Pharmaceutical Holdings 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Sihuan Pharmaceutical Holdings 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. Over the most recent three years, Sihuan Pharmaceutical Holdings Group recorded free cash flow worth 68% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While it is always sensible to investigate a company's debt, in this case Sihuan Pharmaceutical Holdings Group has CN¥4.78b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 68% of that EBIT to free cash flow, bringing in -CN¥504m. So we are not troubled with Sihuan Pharmaceutical Holdings Group'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. For instance, we've identified 1 warning sign for Sihuan Pharmaceutical Holdings Group that you should be aware of.

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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