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. We note that Lepu Biopharma Co., Ltd. (HKG:2157) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 Lepu Biopharma's Net Debt?
As you can see below, at the end of December 2023, Lepu Biopharma had CN¥694.3m of debt, up from CN¥650.0m a year ago. Click the image for more detail. On the flip side, it has CN¥489.6m in cash leading to net debt of about CN¥204.7m.
A Look At Lepu Biopharma's Liabilities
Zooming in on the latest balance sheet data, we can see that Lepu Biopharma had liabilities of CN¥899.6m due within 12 months and liabilities of CN¥596.0m due beyond that. Offsetting these obligations, it had cash of CN¥489.6m as well as receivables valued at CN¥158.1m due within 12 months. So its liabilities total CN¥847.9m more than the combination of its cash and short-term receivables.
Of course, Lepu Biopharma has a market capitalization of CN¥6.52b, 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. 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 Lepu Biopharma's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
In the last year Lepu Biopharma wasn't profitable at an EBIT level, but managed to grow its revenue by 1,347%, to CN¥225m. That's virtually the hole-in-one of revenue growth!
Caveat Emptor
Even though Lepu Biopharma managed to grow its top line quite deftly, the cold hard truth is that it is losing money on the EBIT line. Indeed, it lost CN¥390m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. For example, we would not want to see a repeat of last year's loss of CN¥22m. So to be blunt we do think it is risky. 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. We've identified 1 warning sign with Lepu Biopharma , and understanding them should be part of your investment process.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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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.