Guangzhou Baiyunshan Pharmaceutical Holdings (HKG:874) Could Easily Take On More Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We can see that Guangzhou Baiyunshan Pharmaceutical Holdings Company Limited (HKG:874) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. 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 examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Guangzhou Baiyunshan Pharmaceutical Holdings

How Much Debt Does Guangzhou Baiyunshan Pharmaceutical Holdings Carry?

You can click the graphic below for the historical numbers, but it shows that as of December 2021 Guangzhou Baiyunshan Pharmaceutical Holdings had CN¥9.21b of debt, an increase on CN¥8.76b, over one year. However, its balance sheet shows it holds CN¥22.4b in cash, so it actually has CN¥13.2b net cash.

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¥32.3b falling due within a year, and liabilities of CN¥2.54b due beyond that. Offsetting this, it had CN¥22.4b in cash and CN¥18.5b in receivables that were due within 12 months. So it actually has CN¥6.07b more liquid assets than total liabilities.

This surplus suggests that Guangzhou Baiyunshan Pharmaceutical Holdings has a conservative balance sheet, and could probably eliminate its debt without much difficulty. 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.

In addition to that, we're happy to report that Guangzhou Baiyunshan Pharmaceutical Holdings has boosted its EBIT by 31%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. 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're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Guangzhou Baiyunshan Pharmaceutical 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, Guangzhou Baiyunshan Pharmaceutical Holdings recorded free cash flow worth 64% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While it is always sensible to investigate a company's debt, in this case Guangzhou Baiyunshan Pharmaceutical Holdings has CN¥13.2b in net cash and a decent-looking balance sheet. And we liked the look of last year's 31% year-on-year EBIT growth. 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. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 1 warning sign for Guangzhou Baiyunshan Pharmaceutical Holdings you should be aware of.

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.