Does CK Life Sciences Int'l. (Holdings) (HKG:775) Have A Healthy Balance Sheet?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that CK Life Sciences Int'l., (Holdings) Inc. (HKG:775) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. 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. 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 thing to do when considering how much debt a business uses is to look at 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?

The image below, which you can click on for greater detail, shows that at June 2021 CK Life Sciences Int'l. (Holdings) had debt of HK$5.60b, up from HK$5.34b in one year. However, because it has a cash reserve of HK$684.3m, its net debt is less, at about HK$4.92b.

A Look At CK Life Sciences Int'l. (Holdings)'s Liabilities

We can see from the most recent balance sheet that CK Life Sciences Int'l. (Holdings) had liabilities of HK$1.72b falling due within a year, and liabilities of HK$5.41b due beyond that. Offsetting these obligations, it had cash of HK$684.3m as well as receivables valued at HK$1.02b due within 12 months. So its liabilities total HK$5.42b more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of HK$7.11b, so it does suggest shareholders should keep an eye on CK Life Sciences Int'l. (Holdings)'s use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Weak interest cover of 0.51 times and a disturbingly high net debt to EBITDA ratio of 21.9 hit our confidence in CK Life Sciences Int'l. (Holdings) like a one-two punch to the gut. The debt burden here is substantial. Worse, CK Life Sciences Int'l. (Holdings)'s EBIT was down 74% over the last year. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. There's no doubt that we learn most about debt from the balance sheet. But it is CK Life Sciences Int'l. (Holdings)'s earnings that will influence how the balance sheet holds up in the future. 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. In the last three years, CK Life Sciences Int'l. (Holdings)'s free cash flow amounted to 20% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

On the face of it, CK Life Sciences Int'l. (Holdings)'s interest cover left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. And furthermore, its conversion of EBIT to free cash flow also fails to instill confidence. After considering the datapoints discussed, we think CK Life Sciences Int'l. (Holdings) has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Be aware that CK Life Sciences Int'l. (Holdings) is showing 3 warning signs in our investment analysis , and 2 of those can't be ignored...

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.
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