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. We can see that Tianjin Pharmaceutical Da Ren Tang Group Corporation Limited (SHSE:600329) does use debt in its business. But the more important question is: how much risk is that debt creating?
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 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does Tianjin Pharmaceutical Da Ren Tang Group Carry?
You can click the graphic below for the historical numbers, but it shows that as of December 2023 Tianjin Pharmaceutical Da Ren Tang Group had CN¥332.8m of debt, an increase on CN¥262.9m, over one year. But it also has CN¥2.19b in cash to offset that, meaning it has CN¥1.85b net cash.
How Strong Is Tianjin Pharmaceutical Da Ren Tang Group's Balance Sheet?
The latest balance sheet data shows that Tianjin Pharmaceutical Da Ren Tang Group had liabilities of CN¥3.23b due within a year, and liabilities of CN¥351.9m falling due after that. Offsetting these obligations, it had cash of CN¥2.19b as well as receivables valued at CN¥2.69b due within 12 months. So it actually has CN¥1.29b more liquid assets than total liabilities.
This surplus suggests that Tianjin Pharmaceutical Da Ren Tang Group has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Tianjin Pharmaceutical Da Ren Tang Group boasts net cash, so it's fair to say it does not have a heavy debt load!
And we also note warmly that Tianjin Pharmaceutical Da Ren Tang Group grew its EBIT by 19% last year, making its debt load easier to handle. 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 Tianjin Pharmaceutical Da Ren Tang Group'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. While Tianjin Pharmaceutical Da Ren Tang Group 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. During the last three years, Tianjin Pharmaceutical Da Ren Tang Group generated free cash flow amounting to a very robust 88% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.
Summing Up
While it is always sensible to investigate a company's debt, in this case Tianjin Pharmaceutical Da Ren Tang Group has CN¥1.85b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 88% of that EBIT to free cash flow, bringing in CN¥548m. So is Tianjin Pharmaceutical Da Ren Tang Group's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. We've identified 1 warning sign with Tianjin Pharmaceutical Da Ren Tang Group , and understanding them should be part of your investment process.
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.