China Grand Pharmaceutical and Healthcare Holdings (HKG:512) Seems To Use Debt Rather Sparingly

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.' 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 China Grand Pharmaceutical and Healthcare Holdings Limited (HKG:512) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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. 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 China Grand Pharmaceutical and Healthcare Holdings

What Is China Grand Pharmaceutical and Healthcare Holdings's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2021 China Grand Pharmaceutical and Healthcare Holdings had debt of HK$2.89b, up from HK$2.72b in one year. However, its balance sheet shows it holds HK$3.16b in cash, so it actually has HK$273.4m net cash.

A Look At China Grand Pharmaceutical and Healthcare Holdings' Liabilities

The latest balance sheet data shows that China Grand Pharmaceutical and Healthcare Holdings had liabilities of HK$4.43b due within a year, and liabilities of HK$2.24b falling due after that. Offsetting this, it had HK$3.16b in cash and HK$2.33b in receivables that were due within 12 months. So its liabilities total HK$1.19b more than the combination of its cash and short-term receivables.

Given China Grand Pharmaceutical and Healthcare Holdings has a market capitalization of HK$22.4b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, China Grand Pharmaceutical and Healthcare Holdings also has more cash than debt, so we're pretty confident it can manage its debt safely.

In addition to that, we're happy to report that China Grand Pharmaceutical and Healthcare Holdings has boosted its EBIT by 35%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if China Grand Pharmaceutical and Healthcare Holdings 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. While China Grand Pharmaceutical and Healthcare 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. Over the most recent three years, China Grand Pharmaceutical and Healthcare Holdings recorded free cash flow worth 78% 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

We could understand if investors are concerned about China Grand Pharmaceutical and Healthcare Holdings's liabilities, but we can be reassured by the fact it has has net cash of HK$273.4m. And it impressed us with its EBIT growth of 35% over the last year. So is China Grand Pharmaceutical and Healthcare Holdings's debt a risk? It doesn't seem so to us. 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. To that end, you should be aware of the 2 warning signs we've spotted with China Grand Pharmaceutical and Healthcare Holdings .

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

When trading stocks or any other investment, use the platform considered by many to be the Professional's Gateway to the Worlds Market, Interactive Brokers. You get the lowest-cost* trading on stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted

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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.