Ocean Bio-Chem (NASDAQ:OBCI) Seems To Use Debt Rather Sparingly

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.' 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 Ocean Bio-Chem, Inc. (NASDAQ:OBCI) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Ocean Bio-Chem

How Much Debt Does Ocean Bio-Chem Carry?

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. But on the other hand it also has US$6.58m in cash, leading to a US$2.33m net cash position.

A Look At Ocean Bio-Chem's Liabilities

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 this, it had US$6.58m in cash and US$17.4m in receivables that were due within 12 months. So it can boast 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. Simply put, the fact that Ocean Bio-Chem has more cash than debt is arguably a good indication that it can manage its debt safely.

Even more impressive was the fact that Ocean Bio-Chem grew its EBIT by 227% over twelve months. That boost will make it even easier to pay down debt going forward. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Ocean Bio-Chem 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. 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 weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While it is always sensible to investigate a company's debt, in this case Ocean Bio-Chem has US$2.33m in net cash and a decent-looking balance sheet. And we liked the look of last year's 227% year-on-year EBIT growth. 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. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 1 warning sign for Ocean Bio-Chem you should be aware of.

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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