Is Ocean Bio-Chem (NASDAQ:OBCI) Using Too Much Debt?

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.' 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. Importantly, Ocean Bio-Chem, Inc. (NASDAQ:OBCI) does carry debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Ocean Bio-Chem

What Is Ocean Bio-Chem's Debt?

You can click the graphic below for the historical numbers, but it shows that Ocean Bio-Chem had US$4.25m of debt in September 2020, down from US$4.61m, one year before. However, it does have US$6.58m in cash offsetting this, leading to net cash of US$2.33m.

How Strong Is Ocean Bio-Chem's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Ocean Bio-Chem had liabilities of US$6.71m due within 12 months and liabilities of US$4.46m due beyond that. Offsetting these obligations, it had cash of US$6.58m as well as receivables valued at US$17.4m due within 12 months. So it actually has US$12.8m more liquid assets than total liabilities.

This surplus suggests that Ocean Bio-Chem has a conservative balance sheet, and could probably eliminate its debt without much difficulty. 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 227% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But it is Ocean Bio-Chem'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 company can only pay off debt with cold hard cash, not accounting profits. 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 30% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Ocean Bio-Chem has net cash of US$2.33m, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 227% over the last year. So we don't think Ocean Bio-Chem's use of debt is risky. 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. For example, we've discovered 2 warning signs for Ocean Bio-Chem that you should be aware of before investing here.

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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