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. Importantly, Mayinglong Pharmaceutical Group Co., Ltd. (SHSE:600993) does carry 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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.
See our latest analysis for Mayinglong Pharmaceutical Group
What Is Mayinglong Pharmaceutical Group's Net Debt?
The chart below, which you can click on for greater detail, shows that Mayinglong Pharmaceutical Group had CN¥471.0m in debt in September 2023; about the same as the year before. But on the other hand it also has CN¥2.85b in cash, leading to a CN¥2.38b net cash position.
How Healthy Is Mayinglong Pharmaceutical Group's Balance Sheet?
According to the last reported balance sheet, Mayinglong Pharmaceutical Group had liabilities of CN¥565.4m due within 12 months, and liabilities of CN¥600.6m due beyond 12 months. Offsetting these obligations, it had cash of CN¥2.85b as well as receivables valued at CN¥682.9m due within 12 months. So it actually has CN¥2.37b more liquid assets than total liabilities.
This surplus suggests that Mayinglong Pharmaceutical Group is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that Mayinglong Pharmaceutical Group has more cash than debt is arguably a good indication that it can manage its debt safely.
On the other hand, Mayinglong Pharmaceutical Group's EBIT dived 14%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. When analysing debt levels, the balance sheet is the obvious place to start. But it is Mayinglong Pharmaceutical Group's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Mayinglong Pharmaceutical Group may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. In the last three years, Mayinglong Pharmaceutical Group's free cash flow amounted to 50% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.
Summing Up
While we empathize with investors who find debt concerning, you should keep in mind that Mayinglong Pharmaceutical Group has net cash of CN¥2.38b, as well as more liquid assets than liabilities. So we don't have any problem with Mayinglong Pharmaceutical Group's use of debt. 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. For example, we've discovered 2 warning signs for Mayinglong Pharmaceutical Group (1 shouldn't be ignored!) that you should be aware of before investing here.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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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.