Extrawell Pharmaceutical Holdings (HKG:858) Is Making Moderate Use Of 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 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. As with many other companies Extrawell Pharmaceutical Holdings Limited (HKG:858) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. 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. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Extrawell Pharmaceutical Holdings

What Is Extrawell Pharmaceutical Holdings's Debt?

As you can see below, at the end of September 2023, Extrawell Pharmaceutical Holdings had HK$107.5m of debt, up from HK$90.5m a year ago. Click the image for more detail. However, it also had HK$95.8m in cash, and so its net debt is HK$11.7m.

How Strong Is Extrawell Pharmaceutical Holdings' Balance Sheet?

The latest balance sheet data shows that Extrawell Pharmaceutical Holdings had liabilities of HK$51.5m due within a year, and liabilities of HK$114.2m falling due after that. On the other hand, it had cash of HK$95.8m and HK$57.9m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$12.0m.

Given Extrawell Pharmaceutical Holdings has a market capitalization of HK$81.3m, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. When analysing debt levels, the balance sheet is the obvious place to start. But it is Extrawell Pharmaceutical Holdings's earnings that will influence how the balance sheet holds up in the future. 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.

Over 12 months, Extrawell Pharmaceutical Holdings reported revenue of HK$69m, which is a gain of 6.3%, although it did not report any earnings before interest and tax. That rate of growth is a bit slow for our taste, but it takes all types to make a world.

Caveat Emptor

Importantly, Extrawell Pharmaceutical Holdings had an earnings before interest and tax (EBIT) loss over the last year. To be specific the EBIT loss came in at HK$7.0m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled HK$5.4m in negative free cash flow over the last twelve months. So in short it's a really risky stock. 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. Be aware that Extrawell Pharmaceutical Holdings is showing 2 warning signs in our investment analysis , and 1 of those doesn't sit too well with us...

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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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.