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.' 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 should shareholders be worried about its use of debt?
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is China Biotech Services Holdings's Net Debt?
The image below, which you can click on for greater detail, shows that at June 2023 China Biotech Services Holdings had debt of HK$68.9m, up from HK$61.4m in one year. But on the other hand it also has HK$245.4m in cash, leading to a HK$176.5m net cash position.
How Healthy Is China Biotech Services Holdings' Balance Sheet?
The latest balance sheet data shows that China Biotech Services Holdings had liabilities of HK$172.6m due within a year, and liabilities of HK$74.6m falling due after that. Offsetting these obligations, it had cash of HK$245.4m as well as receivables valued at HK$90.5m due within 12 months. So it can boast HK$88.7m more liquid assets than total liabilities.
This surplus suggests that China Biotech Services Holdings is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Succinctly put, China Biotech Services Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!
In fact China Biotech Services Holdings's saving grace is its low debt levels, because its EBIT has tanked 64% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. 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.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While China Biotech Services Holdings has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, China Biotech Services Holdings recorded free cash flow worth a fulsome 99% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.
While we empathize with investors who find debt concerning, you should keep in mind that China Biotech Services Holdings has net cash of HK$176.5m, as well as more liquid assets than liabilities. The cherry on top was that in converted 99% of that EBIT to free cash flow, bringing in HK$513m. So is China Biotech Services Holdings's debt a risk? It doesn't seem so to us. 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 1 warning sign for China Biotech Services Holdings that you should be aware of before investing here.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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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.
China Biotech Services Holdings
China Biotech Services Holdings Limited, an investment holding company, provides medical laboratory testing and health check services in the People’s Republic of China and Hong Kong.
Excellent balance sheet with acceptable track record.