Does Lee's Pharmaceutical Holdings (HKG:950) Have A Healthy Balance Sheet?

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.' 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. As with many other companies Lee's Pharmaceutical Holdings Limited (HKG:950) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Lee's Pharmaceutical Holdings

What Is Lee's Pharmaceutical Holdings's Debt?

As you can see below, Lee's Pharmaceutical Holdings had HK$141.4m of debt, at December 2020, which is about the same as the year before. You can click the chart for greater detail. However, its balance sheet shows it holds HK$414.5m in cash, so it actually has HK$273.2m net cash.

How Strong Is Lee's Pharmaceutical Holdings' Balance Sheet?

The latest balance sheet data shows that Lee's Pharmaceutical Holdings had liabilities of HK$944.0m due within a year, and liabilities of HK$193.5m falling due after that. Offsetting this, it had HK$414.5m in cash and HK$386.2m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$336.8m.

Since publicly traded Lee's Pharmaceutical Holdings shares are worth a total of HK$3.54b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Lee's Pharmaceutical Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that Lee's Pharmaceutical Holdings's load is not too heavy, because its EBIT was down 21% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Lee's Pharmaceutical Holdings can strengthen its balance sheet over time. 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 Lee's 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. In the last three years, Lee's Pharmaceutical Holdings created free cash flow amounting to 12% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing up

We could understand if investors are concerned about Lee's Pharmaceutical Holdings's liabilities, but we can be reassured by the fact it has has net cash of HK$273.2m. So although we see some areas for improvement, we're not too worried about Lee's Pharmaceutical Holdings's balance sheet. 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 - Lee's Pharmaceutical Holdings has 1 warning sign we think you should be aware of.

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.

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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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