Is Guangzhou Baiyunshan Pharmaceutical Holdings (HKG:874) A Risky Investment?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Guangzhou Baiyunshan Pharmaceutical Holdings Company Limited (HKG:874) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out 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 2021 Guangzhou Baiyunshan Pharmaceutical Holdings had debt of CN¥9.90b, up from CN¥9.18b in one year. But it also has CN¥21.7b in cash to offset that, meaning it has CN¥11.8b net cash.

How Strong Is Guangzhou Baiyunshan Pharmaceutical Holdings' Balance Sheet?

According to the last reported balance sheet, Guangzhou Baiyunshan Pharmaceutical Holdings had liabilities of CN¥30.6b due within 12 months, and liabilities of CN¥2.32b due beyond 12 months. Offsetting this, it had CN¥21.7b in cash and CN¥18.9b in receivables that were due within 12 months. So it actually has CN¥7.66b 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. Succinctly put, Guangzhou Baiyunshan Pharmaceutical Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

Fortunately, Guangzhou Baiyunshan Pharmaceutical Holdings grew its EBIT by 3.6% in the last year, making that debt load look even more manageable. The balance sheet is clearly the area to focus on when you are analysing debt. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. 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 79% 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¥11.8b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 79% of that EBIT to free cash flow, bringing in CN¥4.7b. So we don't think Guangzhou Baiyunshan Pharmaceutical Holdings's use of debt is risky. 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. For example, we've discovered 1 warning sign for Guangzhou Baiyunshan Pharmaceutical Holdings that you should be aware of before investing here.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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This article by Simply Wall St is general in nature. 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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