Is Excelsior Biopharma (GTSM:6496) Using Too Much Debt?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 can see that Excelsior Biopharma Inc. (GTSM:6496) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Excelsior Biopharma

What Is Excelsior Biopharma's Debt?

As you can see below, at the end of December 2020, Excelsior Biopharma had NT$290.6m of debt, up from none a year ago. Click the image for more detail. However, it does have NT$1.15b in cash offsetting this, leading to net cash of NT$861.3m.

How Healthy Is Excelsior Biopharma's Balance Sheet?

The latest balance sheet data shows that Excelsior Biopharma had liabilities of NT$248.7m due within a year, and liabilities of NT$368.5m falling due after that. Offsetting these obligations, it had cash of NT$1.15b as well as receivables valued at NT$190.1m due within 12 months. So it can boast NT$724.8m more liquid assets than total liabilities.

This surplus liquidity suggests that Excelsior Biopharma's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Succinctly put, Excelsior Biopharma boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Excelsior Biopharma if management cannot prevent a repeat of the 52% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. 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 Excelsior Biopharma 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Excelsior Biopharma has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, Excelsior Biopharma actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

While it is always sensible to investigate a company's debt, in this case Excelsior Biopharma has NT$861.3m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of NT$509m, being 108% of its EBIT. So we don't think Excelsior Biopharma's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Excelsior Biopharma (of which 1 makes us a bit uncomfortable!) you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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. 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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