These 4 Measures Indicate That Guangzhou Baiyunshan Pharmaceutical Holdings (HKG:874) Is Using Debt Reasonably Well

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. We can see that Guangzhou Baiyunshan Pharmaceutical Holdings Company Limited (HKG:874) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Guangzhou Baiyunshan Pharmaceutical Holdings

What Is Guangzhou Baiyunshan Pharmaceutical Holdings's Debt?

As you can see below, at the end of December 2020, Guangzhou Baiyunshan Pharmaceutical Holdings had CN¥8.76b of debt, up from CN¥5.89b a year ago. Click the image for more detail. But on the other hand it also has CN¥19.5b in cash, leading to a CN¥10.8b net cash position.

How Healthy 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¥29.2b due within 12 months and liabilities of CN¥2.31b due beyond that. On the other hand, it had cash of CN¥19.5b and CN¥16.5b worth of receivables due within a year. So it actually has CN¥4.42b 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. Succinctly put, Guangzhou Baiyunshan Pharmaceutical Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

But the bad news is that Guangzhou Baiyunshan Pharmaceutical Holdings has seen its EBIT plunge 14% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Guangzhou Baiyunshan Pharmaceutical Holdings can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept 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¥10.8b 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¥291m. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Guangzhou Baiyunshan Pharmaceutical Holdings (of which 1 is concerning!) 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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