Guangzhou Baiyunshan Pharmaceutical Holdings (HKG:874) Has A Rock Solid Balance Sheet

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. We note that Guangzhou Baiyunshan Pharmaceutical Holdings Company Limited (HKG:874) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

See our latest analysis for Guangzhou Baiyunshan Pharmaceutical Holdings

What Is Guangzhou Baiyunshan Pharmaceutical Holdings's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2021 Guangzhou Baiyunshan Pharmaceutical Holdings had CN¥11.0b of debt, an increase on CN¥8.06b, over one year. However, its balance sheet shows it holds CN¥22.1b in cash, so it actually has CN¥11.1b net cash.

How Strong Is Guangzhou Baiyunshan Pharmaceutical Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Guangzhou Baiyunshan Pharmaceutical Holdings had liabilities of CN¥30.1b due within 12 months and liabilities of CN¥2.58b due beyond that. On the other hand, it had cash of CN¥22.1b and CN¥18.5b worth of receivables due within a year. So it actually has CN¥7.99b more liquid assets than total liabilities.

It's good to see that Guangzhou Baiyunshan Pharmaceutical Holdings has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Given it has easily adequate short term liquidity, we don't think it will have any 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.

In addition to that, we're happy to report that Guangzhou Baiyunshan Pharmaceutical Holdings has boosted its EBIT by 41%, 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. During the last three years, Guangzhou Baiyunshan Pharmaceutical Holdings produced sturdy free cash flow equating to 75% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Guangzhou Baiyunshan Pharmaceutical Holdings has net cash of CN¥11.1b, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 41% over the last year. So we don't think Guangzhou Baiyunshan Pharmaceutical Holdings's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example Guangzhou Baiyunshan Pharmaceutical Holdings has 2 warning signs (and 1 which is a bit concerning) we think you should know about.

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.

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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