We Think Human Stem Cells Institute (MCX:ISKJ) Is Taking Some Risk With Its Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. We can see that Public Joint-Stock Company "Human Stem Cells Institute" (MCX:ISKJ) does use debt in its business. But should shareholders be worried about its use of debt?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Human Stem Cells Institute

What Is Human Stem Cells Institute's Net Debt?

As you can see below, Human Stem Cells Institute had ₽377.6m of debt at June 2019, down from ₽401.9m a year prior. However, because it has a cash reserve of ₽177.9m, its net debt is less, at about ₽199.7m.

How Healthy Is Human Stem Cells Institute's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Human Stem Cells Institute had liabilities of ₽411.1m due within 12 months and liabilities of ₽756.6m due beyond that. On the other hand, it had cash of ₽177.9m and ₽79.7m worth of receivables due within a year. So its liabilities total ₽910.1m more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of ₽1.04b, so it does suggest shareholders should keep an eye on Human Stem Cells Institute's use of debt. This suggests shareholders would heavily diluted if the company needed to shore up its balance sheet in a hurry.

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.

While Human Stem Cells Institute's low debt to EBITDA ratio of 0.88 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 5.9 times last year does give us pause. So we'd recommend keeping a close eye on the impact financing costs are having on the business. It was also good to see that despite losing money on the EBIT line last year, Human Stem Cells Institute turned things around in the last 12 months, delivering and EBIT of ₽193m. 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 Human Stem Cells Institute 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Over the last year, Human Stem Cells Institute reported free cash flow worth 2.0% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

On the face of it, Human Stem Cells Institute's level of total liabilities left us tentative about the stock, and its conversion of EBIT to free cash flow was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at managing its debt, based on its EBITDA,; that's encouraging. Once we consider all the factors above, together, it seems to us that Human Stem Cells Institute's debt is making it a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Consider for instance, the ever-present spectre of investment risk. We've identified 2 warning signs with Human Stem Cells Institute (at least 1 which shouldn't be ignored) , and understanding them should be part of your investment process.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.

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