Is China Biotech Services Holdings (HKG:8037) 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.' 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 note that China Biotech Services Holdings Limited (HKG:8037) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. 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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out the opportunities and risks within the HK Healthcare industry.

What Is China Biotech Services Holdings's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2022 China Biotech Services Holdings had HK$57.9m of debt, an increase on HK$45.2m, over one year. However, it does have HK$204.9m in cash offsetting this, leading to net cash of HK$147.0m.

A Look At China Biotech Services Holdings' Liabilities

We can see from the most recent balance sheet that China Biotech Services Holdings had liabilities of HK$292.7m falling due within a year, and liabilities of HK$59.8m due beyond that. Offsetting this, it had HK$204.9m in cash and HK$255.8m in receivables that were due within 12 months. So it actually has HK$108.2m more liquid assets than total liabilities.

This short term liquidity is a sign that China Biotech Services Holdings could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that China Biotech Services Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.

In fact China Biotech Services Holdings's saving grace is its low debt levels, because its EBIT has tanked 24% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since China Biotech Services Holdings will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. China Biotech Services Holdings may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the most recent two years, China Biotech Services Holdings recorded free cash flow worth 76% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that China Biotech Services Holdings has net cash of HK$147.0m, as well as more liquid assets than liabilities. The cherry on top was that in converted 76% of that EBIT to free cash flow, bringing in HK$222m. So is China Biotech Services Holdings's debt a risk? It doesn't seem so to us. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of China Biotech Services Holdings's earnings per share history for free.

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.

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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.