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. Importantly, CSPC Pharmaceutical Group Limited (HKG:1093) does carry debt. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. 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 step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does CSPC Pharmaceutical Group Carry?
The image below, which you can click on for greater detail, shows that CSPC Pharmaceutical Group had debt of CN¥388.9m at the end of June 2024, a reduction from CN¥450.2m over a year. However, its balance sheet shows it holds CN¥10.8b in cash, so it actually has CN¥10.4b net cash.
How Strong Is CSPC Pharmaceutical Group's Balance Sheet?
According to the last reported balance sheet, CSPC Pharmaceutical Group had liabilities of CN¥10.4b due within 12 months, and liabilities of CN¥988.7m due beyond 12 months. On the other hand, it had cash of CN¥10.8b and CN¥12.2b worth of receivables due within a year. So it can boast CN¥11.6b more liquid assets than total liabilities.
This surplus suggests that CSPC Pharmaceutical Group is using debt in a way that is appears to be both safe and conservative. Due to its strong net asset position, it is not likely to face issues with its lenders. Succinctly put, CSPC Pharmaceutical Group boasts net cash, so it's fair to say it does not have a heavy debt load!
On the other hand, CSPC Pharmaceutical Group saw its EBIT drop by 6.2% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if CSPC 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, a company can only pay off debt with cold hard cash, not accounting profits. While CSPC Pharmaceutical 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. In the last three years, CSPC Pharmaceutical Group's free cash flow amounted to 46% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.
Summing Up
While we empathize with investors who find debt concerning, you should keep in mind that CSPC Pharmaceutical Group has net cash of CN¥10.4b, as well as more liquid assets than liabilities. So we don't have any problem with CSPC Pharmaceutical Group's use of debt. 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. Be aware that CSPC 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.
