Stock Analysis

Sihuan Pharmaceutical Holdings Group (HKG:460) Seems To Use Debt Rather Sparingly

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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. We note that Sihuan Pharmaceutical Holdings Group Ltd. (HKG:460) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

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What Is Sihuan Pharmaceutical Holdings Group's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2021 Sihuan Pharmaceutical Holdings Group had debt of CN¥811.9m, up from CN¥587.8m in one year. However, its balance sheet shows it holds CN¥5.31b in cash, so it actually has CN¥4.50b net cash.

SEHK:460 Debt to Equity History September 27th 2021

How Strong Is Sihuan Pharmaceutical Holdings Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Sihuan Pharmaceutical Holdings Group had liabilities of CN¥2.61b due within 12 months and liabilities of CN¥1.02b due beyond that. On the other hand, it had cash of CN¥5.31b and CN¥1.16b worth of receivables due within a year. So it can boast CN¥2.84b 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. Due to its strong net asset position, it is not likely to face issues with its lenders. Simply put, the fact that Sihuan Pharmaceutical Holdings Group has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, Sihuan Pharmaceutical Holdings Group grew its EBIT by 74% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. 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. Sihuan Pharmaceutical Holdings 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. In the last three years, Sihuan Pharmaceutical Holdings Group's free cash flow amounted to 37% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Sihuan Pharmaceutical Holdings Group has net cash of CN¥4.50b, as well as more liquid assets than liabilities. And we liked the look of last year's 74% year-on-year EBIT growth. So we don't think Sihuan Pharmaceutical Holdings Group's use of debt is risky. 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. Case in point: We've spotted 1 warning sign for Sihuan Pharmaceutical Holdings Group 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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About SEHK:460

Sihuan Pharmaceutical Holdings Group

Sihuan Pharmaceutical Holdings Group Ltd., an investment holding company, engages in the research and development, manufacture, marketing, and sale of pharmaceutical and medical aesthetic products in the People’s Republic of China.

Mediocre balance sheet second-rate dividend payer.