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 note that Ocean Bio-Chem, Inc. (NASDAQ:OBCI) does have debt on its balance sheet. But is this debt a concern to shareholders?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.
What Is Ocean Bio-Chem's Net Debt?
The image below, which you can click on for greater detail, shows that Ocean Bio-Chem had debt of US$4.01m at the end of March 2021, a reduction from US$4.48m over a year. But on the other hand it also has US$11.2m in cash, leading to a US$7.15m net cash position.
How Strong Is Ocean Bio-Chem's Balance Sheet?
According to the last reported balance sheet, Ocean Bio-Chem had liabilities of US$5.61m due within 12 months, and liabilities of US$4.07m due beyond 12 months. On the other hand, it had cash of US$11.2m and US$11.5m worth of receivables due within a year. So it can boast US$13.0m more liquid assets than total liabilities.
This short term liquidity is a sign that Ocean Bio-Chem could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Ocean Bio-Chem boasts net cash, so it's fair to say it does not have a heavy debt load!
Even more impressive was the fact that Ocean Bio-Chem grew its EBIT by 220% over twelve months. That boost will make it even easier to pay down debt going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Ocean Bio-Chem's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Ocean Bio-Chem may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. In the last three years, Ocean Bio-Chem's free cash flow amounted to 42% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.
While we empathize with investors who find debt concerning, you should keep in mind that Ocean Bio-Chem has net cash of US$7.15m, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 220% over the last year. So is Ocean Bio-Chem's debt a risk? It doesn't seem so to us. We'd be very excited to see if Ocean Bio-Chem insiders have been snapping up shares. If you are too, then click on this link right now to take a (free) peek at our list of reported insider transactions.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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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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