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. As with many other companies China Resources Double-Crane Pharmaceutical Co.,Ltd. (SHSE:600062) makes use of 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. If things get really bad, the lenders can take control of the business. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does China Resources Double-Crane PharmaceuticalLtd Carry?
You can click the graphic below for the historical numbers, but it shows that as of March 2024 China Resources Double-Crane PharmaceuticalLtd had CN¥259.7m of debt, an increase on CN¥206.8m, over one year. However, its balance sheet shows it holds CN¥3.65b in cash, so it actually has CN¥3.39b net cash.
How Healthy Is China Resources Double-Crane PharmaceuticalLtd's Balance Sheet?
The latest balance sheet data shows that China Resources Double-Crane PharmaceuticalLtd had liabilities of CN¥3.02b due within a year, and liabilities of CN¥458.7m falling due after that. On the other hand, it had cash of CN¥3.65b and CN¥2.62b worth of receivables due within a year. So it can boast CN¥2.80b more liquid assets than total liabilities.
This surplus suggests that China Resources Double-Crane PharmaceuticalLtd has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that China Resources Double-Crane PharmaceuticalLtd has more cash than debt is arguably a good indication that it can manage its debt safely.
Also good is that China Resources Double-Crane PharmaceuticalLtd grew its EBIT at 17% over the last year, further increasing its ability to manage debt. 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 Resources Double-Crane PharmaceuticalLtd'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 company can only pay off debt with cold hard cash, not accounting profits. China Resources Double-Crane PharmaceuticalLtd 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. During the last three years, China Resources Double-Crane PharmaceuticalLtd produced sturdy free cash flow equating to 70% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
Summing Up
While we empathize with investors who find debt concerning, you should keep in mind that China Resources Double-Crane PharmaceuticalLtd has net cash of CN¥3.39b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥1.2b, being 70% of its EBIT. So is China Resources Double-Crane PharmaceuticalLtd'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. To that end, you should be aware of the 1 warning sign we've spotted with China Resources Double-Crane PharmaceuticalLtd .
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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.