Is Essex Bio-Technology (HKG:1061) Using Too Much Debt?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Essex Bio-Technology Limited (HKG:1061) does use debt in its business. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Essex Bio-Technology

What Is Essex Bio-Technology's Debt?

As you can see below, Essex Bio-Technology had HK$559.9m of debt, at December 2021, which is about the same as the year before. You can click the chart for greater detail. But it also has HK$671.4m in cash to offset that, meaning it has HK$111.5m 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$689.6m due within 12 months and liabilities of HK$439.6m due beyond that. Offsetting these obligations, it had cash of HK$671.4m as well as receivables valued at HK$714.2m due within 12 months. So it can boast HK$256.4m more liquid assets than total liabilities.

This short term liquidity is a sign that Essex Bio-Technology could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Essex Bio-Technology boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that Essex Bio-Technology has boosted its EBIT by 57%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Essex Bio-Technology 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. 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. In the last three years, Essex Bio-Technology created free cash flow amounting to 18% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing up

While it is always sensible to investigate a company's debt, in this case Essex Bio-Technology has HK$111.5m in net cash and a decent-looking balance sheet. And we liked the look of last year's 57% year-on-year EBIT growth. So we don't think Essex Bio-Technology's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Essex Bio-Technology has 1 warning sign we think you should be aware of.

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.