Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 note that Haisco Pharmaceutical Group Co., Ltd. (SZSE:002653) does have debt on its balance sheet. But is this debt a concern to shareholders?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

How Much Debt Does Haisco Pharmaceutical Group Carry?

As you can see below, at the end of March 2024, Haisco Pharmaceutical Group had CN¥2.03b of debt, up from CN¥1.82b a year ago. Click the image for more detail. However, because it has a cash reserve of CN¥1.51b, its net debt is less, at about CN¥517.7m.

A Look At Haisco Pharmaceutical Group's Liabilities

Zooming in on the latest balance sheet data, we can see that Haisco Pharmaceutical Group had liabilities of CN¥1.50b due within 12 months and liabilities of CN¥1.06b due beyond that. Offsetting this, it had CN¥1.51b in cash and CN¥956.5m in receivables that were due within 12 months. So its liabilities total CN¥93.3m more than the combination of its cash and short-term receivables.

Having regard to Haisco Pharmaceutical Group's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the CN¥33.9b company is short on cash, but still worth keeping an eye on the balance sheet.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). 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).

Haisco Pharmaceutical Group's net debt is only 0.96 times its EBITDA. And its EBIT covers its interest expense a whopping 19.8 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Better yet, Haisco Pharmaceutical Group grew its EBIT by 118% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Haisco Pharmaceutical Group can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Haisco Pharmaceutical Group saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Happily, Haisco Pharmaceutical Group's impressive interest cover implies it has the upper hand on its debt. But we must concede we find its conversion of EBIT to free cash flow has the opposite effect. All these things considered, it appears that Haisco Pharmaceutical Group can comfortably handle its current debt levels. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Be aware that Haisco Pharmaceutical Group is showing 1 warning sign in our investment analysis , you should know about...

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.

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