Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Shijiazhuang Yiling Pharmaceutical Co., Ltd. (SZSE:002603) does use debt in its business. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
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. If things get really bad, the lenders can take control of the business. 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. 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.
What Is Shijiazhuang Yiling Pharmaceutical's Net Debt?
The image below, which you can click on for greater detail, shows that at March 2024 Shijiazhuang Yiling Pharmaceutical had debt of CN¥1.40b, up from CN¥1.06b in one year. On the flip side, it has CN¥1.30b in cash leading to net debt of about CN¥99.0m.
A Look At Shijiazhuang Yiling Pharmaceutical's Liabilities
Zooming in on the latest balance sheet data, we can see that Shijiazhuang Yiling Pharmaceutical had liabilities of CN¥4.29b due within 12 months and liabilities of CN¥1.10b due beyond that. Offsetting this, it had CN¥1.30b in cash and CN¥3.11b in receivables that were due within 12 months. So it has liabilities totalling CN¥976.3m more than its cash and near-term receivables, combined.
Given Shijiazhuang Yiling Pharmaceutical has a market capitalization of CN¥31.0b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. But either way, Shijiazhuang Yiling Pharmaceutical has virtually no net debt, so it's fair to say it does not have a heavy debt load!
In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
Shijiazhuang Yiling Pharmaceutical has very little debt (net of cash), and boasts a debt to EBITDA ratio of 0.092 and EBIT of 191 times the interest expense. So relative to past earnings, the debt load seems trivial. In fact Shijiazhuang Yiling Pharmaceutical's saving grace is its low debt levels, because its EBIT has tanked 86% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Shijiazhuang Yiling 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. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the most recent three years, Shijiazhuang Yiling Pharmaceutical recorded free cash flow worth 59% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
Our View
Based on what we've seen Shijiazhuang Yiling Pharmaceutical is not finding it easy, given its EBIT growth rate, but the other factors we considered give us cause to be optimistic. There's no doubt that its ability to to cover its interest expense with its EBIT is pretty flash. Considering this range of data points, we think Shijiazhuang Yiling Pharmaceutical is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. 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. For instance, we've identified 2 warning signs for Shijiazhuang Yiling Pharmaceutical (1 is potentially serious) 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.