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.' 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. As with many other companies Shenzhen Neptunus Bioengineering Co., Ltd. (SZSE:000078) makes use of debt. 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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.

What Is Shenzhen Neptunus Bioengineering's Debt?

The image below, which you can click on for greater detail, shows that Shenzhen Neptunus Bioengineering had debt of CN¥11.0b at the end of September 2024, a reduction from CN¥12.0b over a year. However, it does have CN¥3.39b in cash offsetting this, leading to net debt of about CN¥7.57b.

How Strong Is Shenzhen Neptunus Bioengineering's Balance Sheet?

We can see from the most recent balance sheet that Shenzhen Neptunus Bioengineering had liabilities of CN¥26.7b falling due within a year, and liabilities of CN¥436.9m due beyond that. On the other hand, it had cash of CN¥3.39b and CN¥20.1b worth of receivables due within a year. So it has liabilities totalling CN¥3.68b more than its cash and near-term receivables, combined.

Shenzhen Neptunus Bioengineering has a market capitalization of CN¥7.45b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Shenzhen Neptunus Bioengineering shareholders face the double whammy of a high net debt to EBITDA ratio (10.3), and fairly weak interest coverage, since EBIT is just 0.60 times the interest expense. The debt burden here is substantial. Even worse, Shenzhen Neptunus Bioengineering saw its EBIT tank 40% over the last 12 months. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Shenzhen Neptunus Bioengineering will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

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, Shenzhen Neptunus Bioengineering burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

On the face of it, Shenzhen Neptunus Bioengineering's conversion of EBIT to free cash flow left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. Having said that, its ability to handle its total liabilities isn't such a worry. It's also worth noting that Shenzhen Neptunus Bioengineering is in the Healthcare industry, which is often considered to be quite defensive. Taking into account all the aforementioned factors, it looks like Shenzhen Neptunus Bioengineering has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 1 warning sign we've spotted with Shenzhen Neptunus Bioengineering .

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.