We Think YiChang HEC ChangJiang Pharmaceutical (HKG:1558) Can Stay On Top Of Its Debt

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that YiChang HEC ChangJiang Pharmaceutical Co., Ltd. (HKG:1558) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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.

What Is YiChang HEC ChangJiang Pharmaceutical's Net Debt?

As you can see below, YiChang HEC ChangJiang Pharmaceutical had CN¥1.92b of debt at December 2024, down from CN¥2.42b a year prior. However, because it has a cash reserve of CN¥1.41b, its net debt is less, at about CN¥513.4m.

How Strong Is YiChang HEC ChangJiang Pharmaceutical's Balance Sheet?

According to the last reported balance sheet, YiChang HEC ChangJiang Pharmaceutical had liabilities of CN¥2.84b due within 12 months, and liabilities of CN¥1.08b due beyond 12 months. On the other hand, it had cash of CN¥1.41b and CN¥2.26b worth of receivables due within a year. So its liabilities total CN¥256.1m more than the combination of its cash and short-term receivables.

Of course, YiChang HEC ChangJiang Pharmaceutical has a market capitalization of CN¥12.3b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

Check out our latest analysis for YiChang HEC ChangJiang Pharmaceutical

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

YiChang HEC ChangJiang Pharmaceutical has a low net debt to EBITDA ratio of only 0.49. And its EBIT covers its interest expense a whopping 35.5 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. It is just as well that YiChang HEC ChangJiang Pharmaceutical's load is not too heavy, because its EBIT was down 76% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. 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 YiChang HEC ChangJiang Pharmaceutical 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, YiChang HEC ChangJiang Pharmaceutical's free cash flow amounted to 22% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

YiChang HEC ChangJiang Pharmaceutical's EBIT growth rate was a real negative on this analysis, although the other factors we considered were considerably better. In particular, we are dazzled with its interest cover. Looking at all this data makes us feel a little cautious about YiChang HEC ChangJiang Pharmaceutical's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. 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. Be aware that YiChang HEC ChangJiang Pharmaceutical is showing 1 warning sign in our investment analysis , you should know about...

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.