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 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, Guizhou Bailing Group Pharmaceutical Co., Ltd. (SZSE:002424) does carry debt. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. 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.
What Is Guizhou Bailing Group Pharmaceutical's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of September 2023 Guizhou Bailing Group Pharmaceutical had CN¥1.74b of debt, an increase on CN¥1.53b, over one year. However, because it has a cash reserve of CN¥306.1m, its net debt is less, at about CN¥1.43b.
How Strong Is Guizhou Bailing Group Pharmaceutical's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Guizhou Bailing Group Pharmaceutical had liabilities of CN¥2.81b due within 12 months and liabilities of CN¥302.7m due beyond that. Offsetting this, it had CN¥306.1m in cash and CN¥2.54b in receivables that were due within 12 months. So it has liabilities totalling CN¥262.2m more than its cash and near-term receivables, combined.
Of course, Guizhou Bailing Group Pharmaceutical has a market capitalization of CN¥10.9b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.
In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Guizhou Bailing Group Pharmaceutical has a debt to EBITDA ratio of 3.8 and its EBIT covered its interest expense 2.7 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Looking on the bright side, Guizhou Bailing Group Pharmaceutical boosted its EBIT by a silky 51% in the last year. Like the milk of human kindness that sort of growth increases resilience, making the company more capable of managing debt. 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 Guizhou Bailing Group Pharmaceutical 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. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Guizhou Bailing Group Pharmaceutical generated free cash flow amounting to a very robust 97% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.
Our View
Happily, Guizhou Bailing Group Pharmaceutical's impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. But we must concede we find its interest cover has the opposite effect. Zooming out, Guizhou Bailing Group Pharmaceutical seems to use debt quite reasonably; and that gets the nod from us. After all, sensible leverage can boost returns on equity. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Guizhou Bailing Group Pharmaceutical's earnings per share history for free.
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.