Here's Why Extrawell Pharmaceutical Holdings (HKG:858) Can Afford Some 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 real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Extrawell Pharmaceutical Holdings

What Is Extrawell Pharmaceutical Holdings's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2023 Extrawell Pharmaceutical Holdings had debt of HK$107.5m, up from HK$90.5m in one year. However, because it has a cash reserve of HK$95.8m, its net debt is less, at about HK$11.7m.

How Strong Is Extrawell Pharmaceutical Holdings' Balance Sheet?

We can see from the most recent balance sheet that Extrawell Pharmaceutical Holdings had liabilities of HK$51.5m falling due within a year, and liabilities of HK$114.2m due beyond that. Offsetting this, it had HK$95.8m in cash and HK$57.9m in receivables that were due within 12 months. So its liabilities total HK$12.0m more than the combination of its cash and short-term receivables.

Since publicly traded Extrawell Pharmaceutical Holdings shares are worth a total of HK$69.3m, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Extrawell Pharmaceutical Holdings will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

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

Over the last twelve months Extrawell Pharmaceutical Holdings produced an earnings before interest and tax (EBIT) loss. Its EBIT loss was a whopping HK$7.0m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. However, it doesn't help that it burned through HK$8.4m of cash over the last year. So suffice it to say we consider the stock very risky. 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. Be aware that Extrawell Pharmaceutical Holdings is showing 3 warning signs in our investment analysis , you should know about...

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.

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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.