Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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 note that Yixintang Pharmaceutical Group Co., Ltd. (SZSE:002727) does have debt on its balance sheet. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.
What Is Yixintang Pharmaceutical Group's Debt?
As you can see below, Yixintang Pharmaceutical Group had CN¥495.5m of debt at September 2024, down from CN¥1.31b a year prior. But it also has CN¥3.24b in cash to offset that, meaning it has CN¥2.74b net cash.
How Strong Is Yixintang Pharmaceutical Group's Balance Sheet?
According to the last reported balance sheet, Yixintang Pharmaceutical Group had liabilities of CN¥7.63b due within 12 months, and liabilities of CN¥1.63b due beyond 12 months. On the other hand, it had cash of CN¥3.24b and CN¥2.27b worth of receivables due within a year. So it has liabilities totalling CN¥3.75b more than its cash and near-term receivables, combined.
Yixintang Pharmaceutical Group has a market capitalization of CN¥7.65b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, Yixintang Pharmaceutical Group boasts net cash, so it's fair to say it does not have a heavy debt load!
The modesty of its debt load may become crucial for Yixintang Pharmaceutical Group if management cannot prevent a repeat of the 62% cut to EBIT over the last year. 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 ultimately the future profitability of the business will decide if Yixintang Pharmaceutical Group can strengthen its balance sheet over time. 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. While Yixintang 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. Happily for any shareholders, Yixintang Pharmaceutical Group actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
Summing Up
While Yixintang Pharmaceutical Group does have more liabilities than liquid assets, it also has net cash of CN¥2.74b. And it impressed us with free cash flow of CN¥1.8b, being 197% of its EBIT. So we are not troubled with Yixintang Pharmaceutical Group's debt use. 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Yixintang Pharmaceutical Group you should know about.
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.
