Warren Buffett famously said, '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 Hunan Jiudian Pharmaceutical Co., Ltd. (SZSE:300705) makes use of debt. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. When we think about a company's use of debt, we first look at cash and debt together.
What Is Hunan Jiudian Pharmaceutical's Debt?
As you can see below, Hunan Jiudian Pharmaceutical had CN¥367.3m of debt at September 2024, down from CN¥633.3m a year prior. But on the other hand it also has CN¥710.0m in cash, leading to a CN¥342.7m net cash position.
How Strong Is Hunan Jiudian Pharmaceutical's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Hunan Jiudian Pharmaceutical had liabilities of CN¥377.7m due within 12 months and liabilities of CN¥479.9m due beyond that. On the other hand, it had cash of CN¥710.0m and CN¥526.3m worth of receivables due within a year. So it actually has CN¥378.7m more liquid assets than total liabilities.
This short term liquidity is a sign that Hunan Jiudian Pharmaceutical could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Hunan Jiudian Pharmaceutical has more cash than debt is arguably a good indication that it can manage its debt safely.
On top of that, Hunan Jiudian Pharmaceutical grew its EBIT by 37% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Hunan Jiudian Pharmaceutical'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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Hunan Jiudian Pharmaceutical has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. In the last three years, Hunan Jiudian Pharmaceutical's free cash flow amounted to 20% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.
Summing Up
While it is always sensible to investigate a company's debt, in this case Hunan Jiudian Pharmaceutical has CN¥342.7m in net cash and a decent-looking balance sheet. And we liked the look of last year's 37% year-on-year EBIT growth. So is Hunan Jiudian Pharmaceutical's debt a risk? It doesn't seem so to us. 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 - Hunan Jiudian Pharmaceutical has 2 warning signs we think 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.