Essex Bio-Technology (HKG:1061) Seems To Use Debt Quite Sensibly

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. Importantly, Essex Bio-Technology Limited (HKG:1061) does carry debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. 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. 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.

Check out our latest analysis for Essex Bio-Technology

What Is Essex Bio-Technology's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Essex Bio-Technology had HK$508.6m of debt in June 2022, down from HK$555.7m, one year before. However, it does have HK$641.1m in cash offsetting this, leading to net cash of HK$132.5m.

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

The latest balance sheet data shows that Essex Bio-Technology had liabilities of HK$621.2m due within a year, and liabilities of HK$430.2m falling due after that. Offsetting this, it had HK$641.1m in cash and HK$566.5m in receivables that were due within 12 months. So it can boast HK$156.2m 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.

Essex Bio-Technology's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of debt. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Essex Bio-Technology 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. In the last three years, Essex Bio-Technology's free cash flow amounted to 25% of its EBIT, less 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$132.5m, as well as more liquid assets than liabilities. So we don't have any problem with Essex Bio-Technology's use of debt. Over time, share prices tend to follow earnings per share, so if you're interested in Essex Bio-Technology, you may well want to click here to check an interactive graph of its earnings per share history.

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.