David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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 3SBio Inc. (HKG:1530) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.
View our latest analysis for 3SBio
How Much Debt Does 3SBio Carry?
The image below, which you can click on for greater detail, shows that at June 2023 3SBio had debt of CN¥4.94b, up from CN¥3.80b in one year. But it also has CN¥6.67b in cash to offset that, meaning it has CN¥1.74b net cash.
How Healthy Is 3SBio's Balance Sheet?
According to the last reported balance sheet, 3SBio had liabilities of CN¥3.56b due within 12 months, and liabilities of CN¥3.65b due beyond 12 months. Offsetting these obligations, it had cash of CN¥6.67b as well as receivables valued at CN¥1.34b due within 12 months. So it actually has CN¥805.6m more liquid assets than total liabilities.
This surplus suggests that 3SBio has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, 3SBio boasts net cash, so it's fair to say it does not have a heavy debt load!
In addition to that, we're happy to report that 3SBio has boosted its EBIT by 42%, thus reducing the spectre of future debt repayments. 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 3SBio 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While 3SBio 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. Looking at the most recent three years, 3SBio recorded free cash flow of 45% of its EBIT, which is weaker 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 3SBio has net cash of CN¥1.74b, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 42% over the last year. So we don't think 3SBio's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 1 warning sign for 3SBio that you should be aware of.
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.