CK Life Sciences Int'l. (Holdings) (HKG:775) Use Of Debt Could Be Considered Risky

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies CK Life Sciences Int'l., (Holdings) Inc. (HKG:775) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. 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 step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for CK Life Sciences Int'l. (Holdings)

How Much Debt Does CK Life Sciences Int'l. (Holdings) Carry?

As you can see below, CK Life Sciences Int'l. (Holdings) had HK$5.42b of debt, at December 2023, which is about the same as the year before. You can click the chart for greater detail. However, because it has a cash reserve of HK$676.2m, its net debt is less, at about HK$4.75b.

How Strong Is CK Life Sciences Int'l. (Holdings)'s Balance Sheet?

The latest balance sheet data shows that CK Life Sciences Int'l. (Holdings) had liabilities of HK$2.10b due within a year, and liabilities of HK$4.96b falling due after that. Offsetting these obligations, it had cash of HK$676.2m as well as receivables valued at HK$1.11b due within 12 months. So its liabilities total HK$5.27b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the HK$3.46b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, CK Life Sciences Int'l. (Holdings) would likely require a major re-capitalisation if it had to pay its creditors today.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Weak interest cover of 0.72 times and a disturbingly high net debt to EBITDA ratio of 12.6 hit our confidence in CK Life Sciences Int'l. (Holdings) like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. Even more troubling is the fact that CK Life Sciences Int'l. (Holdings) actually let its EBIT decrease by 6.7% over the last year. If it keeps going like that paying off its debt will be like running on a treadmill -- a lot of effort for not much advancement. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since CK Life Sciences Int'l. (Holdings) will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the most recent three years, CK Life Sciences Int'l. (Holdings) recorded free cash flow worth 59% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

On the face of it, CK Life Sciences Int'l. (Holdings)'s net debt to EBITDA left us tentative about the stock, and its interest cover was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. We're quite clear that we consider CK Life Sciences Int'l. (Holdings) to be really rather risky, as a result of its balance sheet health. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 4 warning signs for CK Life Sciences Int'l. (Holdings) (2 shouldn't be ignored) you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.