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

Simply Wall St · 10/17 00:22

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. We note that Guangzhou Baiyunshan Pharmaceutical Holdings Company Limited (HKG:874) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Guangzhou Baiyunshan Pharmaceutical Holdings

How Much Debt Does Guangzhou Baiyunshan Pharmaceutical Holdings Carry?

As you can see below, at the end of June 2024, Guangzhou Baiyunshan Pharmaceutical Holdings had CN¥13.1b of debt, up from CN¥12.4b a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥17.1b in cash, so it actually has CN¥3.95b net cash.

debt-equity-history-analysis
SEHK:874 Debt to Equity History October 17th 2024

How Healthy 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¥34.3b falling due within a year, and liabilities of CN¥5.60b due beyond that. On the other hand, it had cash of CN¥17.1b and CN¥22.4b worth of receivables due within a year. So its total liabilities are just about perfectly matched by its shorter-term, liquid assets.

This state of affairs indicates that Guangzhou Baiyunshan Pharmaceutical Holdings' balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the CN¥43.1b company is struggling for cash, we still think it's worth monitoring its balance sheet. While it does have liabilities worth noting, Guangzhou Baiyunshan Pharmaceutical Holdings also has more cash than debt, so we're pretty confident it can manage its debt safely.

But the other side of the story is that Guangzhou Baiyunshan Pharmaceutical Holdings saw its EBIT decline by 9.6% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. There's no doubt that we learn most about debt from the balance sheet. 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 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. During the last three years, Guangzhou Baiyunshan Pharmaceutical Holdings produced sturdy free cash flow equating to 64% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

We could understand if investors are concerned about Guangzhou Baiyunshan Pharmaceutical Holdings's liabilities, but we can be reassured by the fact it has has net cash of CN¥3.95b. So we don't have any problem with Guangzhou Baiyunshan Pharmaceutical Holdings's use of debt. 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. We've identified 1 warning sign with Guangzhou Baiyunshan Pharmaceutical Holdings , and understanding them should be part of your investment process.

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.