The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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, WuXi AppTec Co., Ltd. (SHSE:603259) does carry debt. But should shareholders be worried about its use of debt?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

What Is WuXi AppTec's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2024 WuXi AppTec had debt of CN¥5.77b, up from CN¥4.65b in one year. However, it does have CN¥16.2b in cash offsetting this, leading to net cash of CN¥10.5b.

How Healthy Is WuXi AppTec's Balance Sheet?

According to the last reported balance sheet, WuXi AppTec had liabilities of CN¥13.4b due within 12 months, and liabilities of CN¥5.50b due beyond 12 months. Offsetting this, it had CN¥16.2b in cash and CN¥8.43b in receivables that were due within 12 months. So it actually has CN¥5.76b more liquid assets than total liabilities.

This short term liquidity is a sign that WuXi AppTec could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, WuXi AppTec boasts net cash, so it's fair to say it does not have a heavy debt load!

Also good is that WuXi AppTec grew its EBIT at 10% over the last year, further increasing its ability to manage debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine WuXi AppTec's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. WuXi AppTec 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. Looking at the most recent three years, WuXi AppTec recorded free cash flow of 32% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While it is always sensible to investigate a company's debt, in this case WuXi AppTec has CN¥10.5b in net cash and a decent-looking balance sheet. And it also grew its EBIT by 10% over the last year. So we don't have any problem with WuXi AppTec's use of debt. 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. Case in point: We've spotted 1 warning sign for WuXi AppTec you should be aware of.

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.

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com