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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Henan Lingrui Pharmaceutical Co., Ltd. (SHSE:600285) does use debt in its business. But is this debt a concern to shareholders?
When Is Debt A Problem?
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. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.
How Much Debt Does Henan Lingrui Pharmaceutical Carry?
You can click the graphic below for the historical numbers, but it shows that Henan Lingrui Pharmaceutical had CN¥142.3m of debt in December 2023, down from CN¥151.2m, one year before. But on the other hand it also has CN¥1.50b in cash, leading to a CN¥1.36b net cash position.
How Strong Is Henan Lingrui Pharmaceutical's Balance Sheet?
The latest balance sheet data shows that Henan Lingrui Pharmaceutical had liabilities of CN¥1.90b due within a year, and liabilities of CN¥73.1m falling due after that. On the other hand, it had cash of CN¥1.50b and CN¥510.9m worth of receivables due within a year. So these liquid assets roughly match the total liabilities.
Having regard to Henan Lingrui Pharmaceutical's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the CN¥14.3b company is short on cash, but still worth keeping an eye on the balance sheet. Succinctly put, Henan Lingrui Pharmaceutical boasts net cash, so it's fair to say it does not have a heavy debt load!
On top of that, Henan Lingrui Pharmaceutical grew its EBIT by 57% over the last twelve months, and that growth will make it easier to handle its 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 Henan Lingrui Pharmaceutical'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. Henan Lingrui Pharmaceutical 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. Happily for any shareholders, Henan Lingrui Pharmaceutical actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
Summing Up
While it is always sensible to investigate a company's debt, in this case Henan Lingrui Pharmaceutical has CN¥1.36b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥792m, being 172% of its EBIT. So is Henan Lingrui Pharmaceutical's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Be aware that Henan Lingrui Pharmaceutical is showing 1 warning sign in our investment analysis , you should know about...
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.