Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 can see that Aurisco Pharmaceutical Co.,Ltd. (SHSE:605116) does use debt in its business. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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.
What Is Aurisco PharmaceuticalLtd's Debt?
You can click the graphic below for the historical numbers, but it shows that as of September 2023 Aurisco PharmaceuticalLtd had CN¥77.5m of debt, an increase on CN¥4.54m, over one year. But it also has CN¥521.0m in cash to offset that, meaning it has CN¥443.4m net cash.
How Strong Is Aurisco PharmaceuticalLtd's Balance Sheet?
According to the last reported balance sheet, Aurisco PharmaceuticalLtd had liabilities of CN¥423.0m due within 12 months, and liabilities of CN¥74.9m due beyond 12 months. On the other hand, it had cash of CN¥521.0m and CN¥269.5m worth of receivables due within a year. So it actually has CN¥292.6m more liquid assets than total liabilities.
This surplus suggests that Aurisco PharmaceuticalLtd has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Aurisco PharmaceuticalLtd boasts net cash, so it's fair to say it does not have a heavy debt load!
And we also note warmly that Aurisco PharmaceuticalLtd grew its EBIT by 16% last year, making its debt load easier to handle. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Aurisco 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. While Aurisco PharmaceuticalLtd 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. Considering the last three years, Aurisco PharmaceuticalLtd actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.
Summing Up
While it is always sensible to investigate a company's debt, in this case Aurisco PharmaceuticalLtd has CN¥443.4m in net cash and a decent-looking balance sheet. And we liked the look of last year's 16% year-on-year EBIT growth. So we don't have any problem with Aurisco PharmaceuticalLtd's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 1 warning sign we've spotted with Aurisco PharmaceuticalLtd .
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.