Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that ‘Volatility is far from synonymous with risk.’ 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 Hybio Pharmaceutical Co., Ltd. (SZSE:300199) 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. If things get really bad, the lenders can take control of the business. 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. 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. When we think about a company’s use of debt, we first look at cash and debt together.
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What Is Hybio Pharmaceutical’s Debt?
As you can see below, Hybio Pharmaceutical had CN¥1.74b of debt, at September 2023, which is about the same as the year before. You can click the chart for greater detail. However, it also had CN¥51.5m in cash, and so its net debt is CN¥1.69b.
A Look At Hybio Pharmaceutical’s Liabilities
Zooming in on the latest balance sheet data, we can see that Hybio Pharmaceutical had liabilities of CN¥1.24b due within 12 months and liabilities of CN¥906.6m due beyond that. Offsetting these obligations, it had cash of CN¥51.5m as well as receivables valued at CN¥289.2m due within 12 months. So its liabilities total CN¥1.80b more than the combination of its cash and short-term receivables.
Of course, Hybio Pharmaceutical has a market capitalization of CN¥11.6b, 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 Hybio Pharmaceutical’s earnings that will influence how the balance sheet holds up in the future. So if you’re keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Over 12 months, Hybio Pharmaceutical made a loss at the EBIT level, and saw its revenue drop to CN¥575m, which is a fall of 24%. To be frank that doesn’t bode well.
Caveat Emptor
Not only did Hybio Pharmaceutical’s revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). To be specific the EBIT loss came in at CN¥307m. 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. Another cause for caution is that is bled CN¥158m in negative free cash flow over the last twelve months. So suffice it to say we do consider the stock to be 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. For example, we’ve discovered 1 warning sign for Hybio Pharmaceutical that you should be aware of before investing here.
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.