Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. As with many other companies China National Medicines Corporation Ltd. (SHSE:600511) makes use of debt. 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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is China National Medicines's Net Debt?
The image below, which you can click on for greater detail, shows that China National Medicines had debt of CN¥222.8m at the end of September 2023, a reduction from CN¥301.3m over a year. But it also has CN¥7.85b in cash to offset that, meaning it has CN¥7.63b net cash.
How Healthy Is China National Medicines' Balance Sheet?
Zooming in on the latest balance sheet data, we can see that China National Medicines had liabilities of CN¥13.9b due within 12 months and liabilities of CN¥950.8m due beyond that. Offsetting these obligations, it had cash of CN¥7.85b as well as receivables valued at CN¥15.4b due within 12 months. So it actually has CN¥8.47b more liquid assets than total liabilities.
This luscious liquidity implies that China National Medicines' balance sheet is sturdy like a giant sequoia tree. Having regard to this fact, we think its balance sheet is as strong as an ox. Succinctly put, China National Medicines boasts net cash, so it's fair to say it does not have a heavy debt load!
While China National Medicines doesn't seem to have gained much on the EBIT line, at least earnings remain stable for now. 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 China National Medicines's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. China National Medicines may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the most recent three years, China National Medicines recorded free cash flow worth 78% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.
Summing Up
While it is always sensible to investigate a company's debt, in this case China National Medicines has CN¥7.63b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥2.5b, being 78% of its EBIT. So is China National Medicines's debt a risk? It doesn't seem so to us. 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 China National Medicines is showing 1 warning sign in our investment analysis , you should know about...
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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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.