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.' 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 can see that Shandong Jincheng Pharmaceutical Group Co., Ltd (SZSE:300233) does use debt in its business. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does Shandong Jincheng Pharmaceutical Group Carry?
As you can see below, Shandong Jincheng Pharmaceutical Group had CN¥600.1m of debt at June 2024, down from CN¥651.8m a year prior. However, its balance sheet shows it holds CN¥1.07b in cash, so it actually has CN¥474.1m net cash.
How Healthy Is Shandong Jincheng Pharmaceutical Group's Balance Sheet?
We can see from the most recent balance sheet that Shandong Jincheng Pharmaceutical Group had liabilities of CN¥1.43b falling due within a year, and liabilities of CN¥513.5m due beyond that. On the other hand, it had cash of CN¥1.07b and CN¥648.7m worth of receivables due within a year. So it has liabilities totalling CN¥219.4m more than its cash and near-term receivables, combined.
Since publicly traded Shandong Jincheng Pharmaceutical Group shares are worth a total of CN¥4.15b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Shandong Jincheng Pharmaceutical Group also has more cash than debt, so we're pretty confident it can manage its debt safely.
Fortunately, Shandong Jincheng Pharmaceutical Group grew its EBIT by 4.0% in the last year, making that debt load look even more manageable. When analysing debt levels, the balance sheet is the obvious place to start. But it is Shandong Jincheng 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. Shandong Jincheng 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. During the last three years, Shandong Jincheng Pharmaceutical Group produced sturdy free cash flow equating to 55% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
Summing Up
We could understand if investors are concerned about Shandong Jincheng Pharmaceutical Group's liabilities, but we can be reassured by the fact it has has net cash of CN¥474.1m. So we are not troubled with Shandong Jincheng Pharmaceutical Group's debt use. 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. Case in point: We've spotted 1 warning sign for Shandong Jincheng Pharmaceutical Group you should be aware of.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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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.
