These 4 Measures Indicate That Allied Biotech (GTSM:1780) Is Using Debt Reasonably Well

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.' 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. We note that Allied Biotech Corporation (GTSM:1780) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Allied Biotech

What Is Allied Biotech's Net Debt?

As you can see below, at the end of December 2020, Allied Biotech had NT$971.0m of debt, up from NT$687.6m a year ago. Click the image for more detail. However, it also had NT$965.8m in cash, and so its net debt is NT$5.22m.

How Healthy Is Allied Biotech's Balance Sheet?

We can see from the most recent balance sheet that Allied Biotech had liabilities of NT$971.4m falling due within a year, and liabilities of NT$143.9m due beyond that. Offsetting this, it had NT$965.8m in cash and NT$118.3m in receivables that were due within 12 months. So its liabilities total NT$31.2m more than the combination of its cash and short-term receivables.

This state of affairs indicates that Allied Biotech's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the NT$1.57b company is short on cash, but still worth keeping an eye on the balance sheet. Carrying virtually no net debt, Allied Biotech has a very light debt load indeed.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

With debt at a measly 0.032 times EBITDA and EBIT covering interest a whopping 26.9 times, it's clear that Allied Biotech is not a desperate borrower. Indeed relative to its earnings its debt load seems light as a feather. The modesty of its debt load may become crucial for Allied Biotech if management cannot prevent a repeat of the 24% 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. When analysing debt levels, the balance sheet is the obvious place to start. But it is Allied Biotech'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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 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, Allied Biotech recorded free cash flow worth 50% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

Based on what we've seen Allied Biotech is not finding it easy, given its EBIT growth rate, but the other factors we considered give us cause to be optimistic. There's no doubt that its ability to to cover its interest expense with its EBIT is pretty flash. Considering this range of data points, we think Allied Biotech is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. 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. To that end, you should learn about the 3 warning signs we've spotted with Allied Biotech (including 1 which is potentially serious) .

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.

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