Is InnoCare Pharma (HKG:9969) Using Too Much Debt?

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 InnoCare Pharma Limited (HKG:9969) does use debt in its business. But should shareholders be worried about its use of debt?

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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for InnoCare Pharma

What Is InnoCare Pharma's Debt?

As you can see below, InnoCare Pharma had CN¥19.3m of debt at March 2023, down from CN¥1.50b a year prior. However, its balance sheet shows it holds CN¥8.54b in cash, so it actually has CN¥8.52b net cash.

A Look At InnoCare Pharma's Liabilities

According to the last reported balance sheet, InnoCare Pharma had liabilities of CN¥2.04b due within 12 months, and liabilities of CN¥611.3m due beyond 12 months. Offsetting these obligations, it had cash of CN¥8.54b as well as receivables valued at CN¥153.7m due within 12 months. So it can boast CN¥6.05b more liquid assets than total liabilities.

This surplus liquidity suggests that InnoCare Pharma's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. Having regard to this fact, we think its balance sheet is as strong as an ox. Succinctly put, InnoCare Pharma boasts net cash, so it's fair to say it does not have a heavy debt load! When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if InnoCare Pharma 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.

In the last year InnoCare Pharma had a loss before interest and tax, and actually shrunk its revenue by 38%, to CN¥696m. To be frank that doesn't bode well.

So How Risky Is InnoCare Pharma?

We have no doubt that loss making companies are, in general, riskier than profitable ones. And we do note that InnoCare Pharma had an earnings before interest and tax (EBIT) loss, over the last year. And over the same period it saw negative free cash outflow of CN¥715m and booked a CN¥781m accounting loss. But the saving grace is the CN¥8.52b on the balance sheet. That kitty means the company can keep spending for growth for at least two years, at current rates. Even though its balance sheet seems sufficiently liquid, debt always makes us a little nervous if a company doesn't produce free cash flow regularly. 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. We've identified 3 warning signs with InnoCare Pharma , and understanding them should be part of your investment process.

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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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.