Does Guangzhou Baiyunshan Pharmaceutical Holdings (HKG:874) Have A Healthy Balance Sheet?

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Guangzhou Baiyunshan Pharmaceutical Holdings Company Limited (HKG:874) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Guangzhou Baiyunshan Pharmaceutical Holdings

What Is Guangzhou Baiyunshan Pharmaceutical Holdings's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2022 Guangzhou Baiyunshan Pharmaceutical Holdings had debt of CN¥10.7b, up from CN¥10.1b in one year. However, it does have CN¥23.6b in cash offsetting this, leading to net cash of CN¥12.9b.

How Strong Is Guangzhou Baiyunshan Pharmaceutical Holdings' Balance Sheet?

We can see from the most recent balance sheet that Guangzhou Baiyunshan Pharmaceutical Holdings had liabilities of CN¥31.2b falling due within a year, and liabilities of CN¥2.64b due beyond that. Offsetting these obligations, it had cash of CN¥23.6b as well as receivables valued at CN¥19.9b due within 12 months. So it actually has CN¥9.61b more liquid assets than total liabilities.

This excess liquidity suggests that Guangzhou Baiyunshan Pharmaceutical Holdings is taking a careful approach to debt. Due to its strong net asset position, it is not likely to face issues with its lenders. Simply put, the fact that Guangzhou Baiyunshan Pharmaceutical Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.

Also good is that Guangzhou Baiyunshan Pharmaceutical Holdings grew its EBIT at 20% over the last year, further increasing its ability to manage 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 Guangzhou Baiyunshan Pharmaceutical Holdings's ability to maintain a healthy balance sheet going forward. 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. Guangzhou Baiyunshan Pharmaceutical Holdings 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. During the last three years, Guangzhou Baiyunshan Pharmaceutical Holdings generated free cash flow amounting to a very robust 96% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case Guangzhou Baiyunshan Pharmaceutical Holdings has CN¥12.9b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥3.6b, being 96% of its EBIT. So is Guangzhou Baiyunshan Pharmaceutical Holdings's debt a risk? It doesn't seem so to us. 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. Be aware that Guangzhou Baiyunshan Pharmaceutical Holdings is showing 1 warning sign in our investment analysis , 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.

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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.