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 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, CanSino Biologics Inc. (HKG:6185) does carry debt. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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, 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 think about a company's use of debt, we first look at cash and debt together.
What Is CanSino Biologics's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of June 2021 CanSino Biologics had CN¥691.7m of debt, an increase on CN¥140.2m, over one year. But it also has CN¥6.71b in cash to offset that, meaning it has CN¥6.02b net cash.
How Strong Is CanSino Biologics' Balance Sheet?
According to the last reported balance sheet, CanSino Biologics had liabilities of CN¥2.82b due within 12 months, and liabilities of CN¥417.1m due beyond 12 months. Offsetting these obligations, it had cash of CN¥6.71b as well as receivables valued at CN¥697.3m due within 12 months. So it actually has CN¥4.17b more liquid assets than total liabilities.
This surplus suggests that CanSino Biologics has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that CanSino Biologics has more cash than debt is arguably a good indication that it can manage its debt safely.
It was also good to see that despite losing money on the EBIT line last year, CanSino Biologics turned things around in the last 12 months, delivering and EBIT of CN¥367m. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine CanSino Biologics'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.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. CanSino Biologics 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. Over the last year, CanSino Biologics saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.
While we empathize with investors who find debt concerning, you should keep in mind that CanSino Biologics has net cash of CN¥6.02b, as well as more liquid assets than liabilities. So we are not troubled with CanSino Biologics's debt use. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example CanSino Biologics has 2 warning signs (and 1 which shouldn't be ignored) we think you should know about.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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.
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