The external fund manager backed by Berkshire Hathaway’s Charlie Munger, Li Lu, makes no bones about it when he says ‘The biggest investment risk is not the volatility of prices, but whether you will suffer a 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 note that China Biotech Services Holdings Limited (HKG:8037) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
Generally speaking, debt only becomes a real problem when a company can’t easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well – and to its own advantage. When we think about a company’s use of debt, we first look at cash and debt together.
What Is China Biotech Services Holdings’s Debt?
The image below, which you can click on for greater detail, shows that at December 2019 China Biotech Services Holdings had debt of HK$28.9m, up from HK$4.87m in one year. However, its balance sheet shows it holds HK$46.8m in cash, so it actually has HK$18.0m net cash.
How Healthy Is China Biotech Services Holdings’s Balance Sheet?
According to the last reported balance sheet, China Biotech Services Holdings had liabilities of HK$53.8m due within 12 months, and liabilities of HK$49.5m due beyond 12 months. Offsetting this, it had HK$46.8m in cash and HK$29.3m in receivables that were due within 12 months. So it has liabilities totalling HK$27.1m more than its cash and near-term receivables, combined.
Of course, China Biotech Services Holdings has a market capitalization of HK$1.16b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, China Biotech Services Holdings boasts net cash, so it’s fair to say it does not have a heavy debt load! There’s no doubt that we learn most about debt from the balance sheet. But you can’t view debt in total isolation; since China Biotech Services Holdings will need earnings to service that debt. 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, China Biotech Services Holdings made a loss at the EBIT level, and saw its revenue drop to HK$59m, which is a fall of 16%. We would much prefer see growth.
So How Risky Is China Biotech Services Holdings?
By their very nature companies that are losing money are more risky than those with a long history of profitability. And in the last year China Biotech Services Holdings had negative earnings before interest and tax (EBIT), truth be told. Indeed, in that time it burnt through HK$38m of cash and made a loss of HK$99m. However, it has net cash of HK$18.0m, so it has a bit of time before it will need more capital. Summing up, we’re a little skeptical of this one, as it seems fairly risky in the absence of free cashflow. 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 example, we’ve discovered 4 warning signs for China Biotech Services Holdings (2 shouldn’t be ignored!) that you should be aware of before investing here.
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.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.
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