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. Importantly, Guangdong Marubi Biotechnology Co., Ltd. (SHSE:603983) does carry debt. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does Guangdong Marubi Biotechnology Carry?
As you can see below, at the end of September 2023, Guangdong Marubi Biotechnology had CN¥256.4m of debt, up from none a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥1.24b in cash, so it actually has CN¥988.2m net cash.
How Strong Is Guangdong Marubi Biotechnology's Balance Sheet?
According to the last reported balance sheet, Guangdong Marubi Biotechnology had liabilities of CN¥711.3m due within 12 months, and liabilities of CN¥19.1m due beyond 12 months. On the other hand, it had cash of CN¥1.24b and CN¥54.7m worth of receivables due within a year. So it actually has CN¥568.9m more liquid assets than total liabilities.
This short term liquidity is a sign that Guangdong Marubi Biotechnology could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Guangdong Marubi Biotechnology has more cash than debt is arguably a good indication that it can manage its debt safely.
But the bad news is that Guangdong Marubi Biotechnology has seen its EBIT plunge 14% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Guangdong Marubi Biotechnology'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 business needs free cash flow to pay off debt; accounting profits just don't cut it. While Guangdong Marubi Biotechnology 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. Over the last three years, Guangdong Marubi Biotechnology saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.
Summing Up
While it is always sensible to investigate a company's debt, in this case Guangdong Marubi Biotechnology has CN¥988.2m in net cash and a decent-looking balance sheet. So we don't have any problem with Guangdong Marubi Biotechnology's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 1 warning sign for Guangdong Marubi Biotechnology 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.