We Think Guangzhou Baiyunshan Pharmaceutical Holdings (HKG:874) Can Manage Its Debt With Ease

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. 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 assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Guangzhou Baiyunshan Pharmaceutical Holdings

What Is Guangzhou Baiyunshan Pharmaceutical Holdings's Debt?

The image below, which you can click on for greater detail, shows that at September 2021 Guangzhou Baiyunshan Pharmaceutical Holdings had debt of CN¥9.84b, up from CN¥8.26b in one year. However, its balance sheet shows it holds CN¥24.0b in cash, so it actually has CN¥14.1b 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¥31.2b falling due within a year, and liabilities of CN¥2.56b due beyond that. On the other hand, it had cash of CN¥24.0b and CN¥17.9b worth of receivables due within a year. So it actually has CN¥8.07b 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. Succinctly put, Guangzhou Baiyunshan Pharmaceutical Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

Also good is that Guangzhou Baiyunshan Pharmaceutical Holdings grew its EBIT at 15% over the last year, further increasing its ability to manage debt. 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 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. Over the last three years, Guangzhou Baiyunshan Pharmaceutical Holdings recorded free cash flow worth a fulsome 85% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

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¥14.1b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥4.9b, being 85% of its EBIT. 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. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 1 warning sign we've spotted with Guangzhou Baiyunshan Pharmaceutical Holdings .

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.