These 4 Measures Indicate That Viva Biotech Holdings (HKG:1873) Is Using Debt Extensively

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.' 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. Importantly, Viva Biotech Holdings (HKG:1873) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Viva Biotech Holdings

What Is Viva Biotech Holdings's Debt?

You can click the graphic below for the historical numbers, but it shows that Viva Biotech Holdings had CN¥2.62b of debt in December 2021, down from CN¥2.95b, one year before. However, it does have CN¥800.9m in cash offsetting this, leading to net debt of about CN¥1.82b.

How Strong Is Viva Biotech Holdings' Balance Sheet?

The latest balance sheet data shows that Viva Biotech Holdings had liabilities of CN¥926.6m due within a year, and liabilities of CN¥3.20b falling due after that. On the other hand, it had cash of CN¥800.9m and CN¥429.7m worth of receivables due within a year. So its liabilities total CN¥2.90b more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of CN¥4.36b, so it does suggest shareholders should keep an eye on Viva Biotech Holdings' use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Viva Biotech Holdings shareholders face the double whammy of a high net debt to EBITDA ratio (6.3), and fairly weak interest coverage, since EBIT is just 1.5 times the interest expense. The debt burden here is substantial. However, it should be some comfort for shareholders to recall that Viva Biotech Holdings actually grew its EBIT by a hefty 105%, over the last 12 months. If that earnings trend continues it will make its debt load much more manageable in the future. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Viva Biotech Holdings can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Viva Biotech Holdings saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

To be frank both Viva Biotech Holdings's net debt to EBITDA and its track record of converting EBIT to free cash flow make us rather uncomfortable with its debt levels. But at least it's pretty decent at growing its EBIT; that's encouraging. Overall, we think it's fair to say that Viva Biotech Holdings has enough debt that there are some real risks around the balance sheet. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Viva Biotech Holdings (of which 1 is significant!) you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.