Is Star Lake BioscienceZhaoqing Guangdong (SHSE:600866) A Risky Investment?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. Importantly, Star Lake Bioscience Co., Inc.Zhaoqing Guangdong (SHSE:600866) does carry debt. But the more important question is: how much risk is that debt creating?

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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Star Lake BioscienceZhaoqing Guangdong

What Is Star Lake BioscienceZhaoqing Guangdong's Net Debt?

The image below, which you can click on for greater detail, shows that Star Lake BioscienceZhaoqing Guangdong had debt of CN¥3.81b at the end of September 2024, a reduction from CN¥4.21b over a year. However, it also had CN¥2.01b in cash, and so its net debt is CN¥1.80b.

A Look At Star Lake BioscienceZhaoqing Guangdong's Liabilities

Zooming in on the latest balance sheet data, we can see that Star Lake BioscienceZhaoqing Guangdong had liabilities of CN¥4.40b due within 12 months and liabilities of CN¥2.15b due beyond that. Offsetting these obligations, it had cash of CN¥2.01b as well as receivables valued at CN¥1.39b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥3.14b.

This deficit isn't so bad because Star Lake BioscienceZhaoqing Guangdong is worth CN¥11.0b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Star Lake BioscienceZhaoqing Guangdong's net debt is only 0.82 times its EBITDA. And its EBIT covers its interest expense a whopping 12.1 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. On top of that, Star Lake BioscienceZhaoqing Guangdong grew its EBIT by 32% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Star Lake BioscienceZhaoqing Guangdong 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Star Lake BioscienceZhaoqing Guangdong actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

The good news is that Star Lake BioscienceZhaoqing Guangdong's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And the good news does not stop there, as its conversion of EBIT to free cash flow also supports that impression! Overall, we don't think Star Lake BioscienceZhaoqing Guangdong is taking any bad risks, as its debt load seems modest. So we're not worried about the use of a little leverage on the balance sheet. Given Star Lake BioscienceZhaoqing Guangdong has a strong balance sheet is profitable and pays a dividend, it would be good to know how fast its dividends are growing, if at all. You can find out instantly by clicking this link.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.