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 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 note that Jiangsu Sinopep-Allsino Biopharmaceutical Co., Ltd. (SHSE:688076) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

How Much Debt Does Jiangsu Sinopep-Allsino Biopharmaceutical Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 Jiangsu Sinopep-Allsino Biopharmaceutical had CN¥1.13b of debt, an increase on CN¥425.6m, over one year. However, it does have CN¥740.2m in cash offsetting this, leading to net debt of about CN¥386.7m.

A Look At Jiangsu Sinopep-Allsino Biopharmaceutical's Liabilities

According to the last reported balance sheet, Jiangsu Sinopep-Allsino Biopharmaceutical had liabilities of CN¥1.25b due within 12 months, and liabilities of CN¥341.3m due beyond 12 months. Offsetting these obligations, it had cash of CN¥740.2m as well as receivables valued at CN¥493.6m due within 12 months. So it has liabilities totalling CN¥361.1m more than its cash and near-term receivables, combined.

Of course, Jiangsu Sinopep-Allsino Biopharmaceutical has a market capitalization of CN¥16.4b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). 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).

Jiangsu Sinopep-Allsino Biopharmaceutical has a low net debt to EBITDA ratio of only 0.69. And its EBIT covers its interest expense a whopping 25.6 times over. So we're pretty relaxed about its super-conservative use of debt. Better yet, Jiangsu Sinopep-Allsino Biopharmaceutical grew its EBIT by 211% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. 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 Jiangsu Sinopep-Allsino Biopharmaceutical 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Jiangsu Sinopep-Allsino Biopharmaceutical burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Jiangsu Sinopep-Allsino Biopharmaceutical's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But the stark truth is that we are concerned by its conversion of EBIT to free cash flow. Looking at all the aforementioned factors together, it strikes us that Jiangsu Sinopep-Allsino Biopharmaceutical can handle its debt fairly comfortably. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Jiangsu Sinopep-Allsino Biopharmaceutical (of which 1 is potentially serious!) 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.