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. We can see that Shanghai Henlius Biotech, Inc. (HKG:2696) 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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.
What Is Shanghai Henlius Biotech's Debt?
As you can see below, at the end of December 2019, Shanghai Henlius Biotech had CN¥386.5m of debt, up from CN¥336.1m a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥2.30b in cash, so it actually has CN¥1.91b net cash.
How Strong Is Shanghai Henlius Biotech's Balance Sheet?
We can see from the most recent balance sheet that Shanghai Henlius Biotech had liabilities of CN¥959.6m falling due within a year, and liabilities of CN¥939.8m due beyond that. Offsetting this, it had CN¥2.30b in cash and CN¥29.8m in receivables that were due within 12 months. So it can boast CN¥431.5m more liquid assets than total liabilities.
This surplus suggests that Shanghai Henlius Biotech has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Shanghai Henlius Biotech has more cash than debt is arguably a good indication that it can manage its debt safely. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Shanghai Henlius Biotech can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Over 12 months, Shanghai Henlius Biotech reported revenue of CN¥91m, which is a gain of 1125%, although it did not report any earnings before interest and tax. That's virtually the hole-in-one of revenue growth!
So How Risky Is Shanghai Henlius Biotech?
We have no doubt that loss making companies are, in general, riskier than profitable ones. And we do note that Shanghai Henlius Biotech had negative earnings before interest and tax (EBIT), over the last year. And over the same period it saw negative free cash outflow of CN¥1.3b and booked a CN¥875m accounting loss. However, it has net cash of CN¥1.91b, so it has a bit of time before it will need more capital. The good news for shareholders is that Shanghai Henlius Biotech has dazzling revenue growth, so there's a very good chance it can boost its free cash flow in the years to come. While unprofitable companies can be risky, they can also grow hard and fast in those pre-profit years. When we look at a riskier company, we like to check how their profits (or losses) are trending over time. Today, we're providing readers this interactive graph showing how Shanghai Henlius Biotech's profit, revenue, and operating cashflow have changed over the last few years.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
If you spot an error that warrants correction, please contact the editor at email@example.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.