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. Importantly, Austar Lifesciences Limited (HKG:6118) does carry debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. 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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Austar Lifesciences

What Is Austar Lifesciences's Net Debt?

As you can see below, at the end of December 2020, Austar Lifesciences had CN¥31.4m of debt, up from CN¥21.6m a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥178.1m in cash, so it actually has CN¥146.7m net cash.

How Strong Is Austar Lifesciences' Balance Sheet?

The latest balance sheet data shows that Austar Lifesciences had liabilities of CN¥805.7m due within a year, and liabilities of CN¥48.6m falling due after that. Offsetting this, it had CN¥178.1m in cash and CN¥515.5m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥160.7m.

Given Austar Lifesciences has a market capitalization of CN¥2.29b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Austar Lifesciences boasts net cash, so it's fair to say it does not have a heavy debt load!

Better yet, Austar Lifesciences grew its EBIT by 430% last year, which is an impressive improvement. 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 company can only pay off debt with cold hard cash, not accounting profits. 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. In the last two years, Austar Lifesciences created free cash flow amounting to 16% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing up

We could understand if investors are concerned about Austar Lifesciences's liabilities, but we can be reassured by the fact it has has net cash of CN¥146.7m. And it impressed us with its EBIT growth of 430% over the last year. So we don't think Austar Lifesciences'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. We've identified 2 warning signs 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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