Essex Bio-Technology (HKG:1061) Has A Pretty Healthy Balance Sheet

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Essex Bio-Technology Limited (HKG:1061) 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 is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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.

See our latest analysis for Essex Bio-Technology

What Is Essex Bio-Technology's Net Debt?

The image below, which you can click on for greater detail, shows that Essex Bio-Technology had debt of HK$444.9m at the end of June 2023, a reduction from HK$508.6m over a year. However, its balance sheet shows it holds HK$510.2m in cash, so it actually has HK$65.3m net cash.

How Strong Is Essex Bio-Technology's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Essex Bio-Technology had liabilities of HK$625.0m due within 12 months and liabilities of HK$396.0m due beyond that. On the other hand, it had cash of HK$510.2m and HK$637.4m worth of receivables due within a year. So it actually has HK$126.5m more liquid assets than total liabilities.

This surplus suggests that Essex Bio-Technology has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Essex Bio-Technology has more cash than debt is arguably a good indication that it can manage its debt safely.

On the other hand, Essex Bio-Technology saw its EBIT drop by 7.1% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Essex Bio-Technology's ability to maintain a healthy balance sheet going forward. 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 company can only pay off debt with cold hard cash, not accounting profits. Essex Bio-Technology 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. Looking at the most recent three years, Essex Bio-Technology recorded free cash flow of 30% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Essex Bio-Technology has net cash of HK$65.3m, as well as more liquid assets than liabilities. So we are not troubled with Essex Bio-Technology's debt use. Given Essex Bio-Technology 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.

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.