Austar Lifesciences (HKG:6118) 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. We can see that Austar Lifesciences Limited (HKG:6118) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Austar Lifesciences

How Much Debt Does Austar Lifesciences Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2020 Austar Lifesciences had CN¥21.6m of debt, an increase on CN¥20.0m, over one year. However, it does have CN¥136.9m in cash offsetting this, leading to net cash of CN¥115.2m.

How Healthy Is Austar Lifesciences's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Austar Lifesciences had liabilities of CN¥708.5m due within 12 months and liabilities of CN¥39.5m due beyond that. Offsetting this, it had CN¥136.9m in cash and CN¥480.3m in receivables that were due within 12 months. So it has liabilities totalling CN¥130.7m more than its cash and near-term receivables, combined.

Since publicly traded Austar Lifesciences shares are worth a total of CN¥1.54b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Austar Lifesciences also has more cash than debt, so we're pretty confident it can manage its debt safely.

Even more impressive was the fact that Austar Lifesciences grew its EBIT by 1,625% over twelve months. That boost will make it even easier to pay down debt going forward. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Austar Lifesciences 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. Austar Lifesciences 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. During the last two years, Austar Lifesciences burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Austar Lifesciences has CN¥115.2m in net cash. And it impressed us with its EBIT growth of 1,625% over the last year. So we don't have any problem with Austar Lifesciences's use of debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Consider for instance, the ever-present spectre of investment risk. We've identified 1 warning sign with Austar Lifesciences , and understanding them should be part of your investment process.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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