Is Avid Bioservices (NASDAQ:CDMO) Using Too Much Debt?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Avid Bioservices, Inc. (NASDAQ:CDMO) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Avid Bioservices

What Is Avid Bioservices's Debt?

The chart below, which you can click on for greater detail, shows that Avid Bioservices had US$140.4m in debt in January 2023; about the same as the year before. However, it also had US$59.9m in cash, and so its net debt is US$80.4m.

How Strong Is Avid Bioservices' Balance Sheet?

We can see from the most recent balance sheet that Avid Bioservices had liabilities of US$87.3m falling due within a year, and liabilities of US$177.7m due beyond that. On the other hand, it had cash of US$59.9m and US$25.2m worth of receivables due within a year. So it has liabilities totalling US$179.9m more than its cash and near-term receivables, combined.

Given Avid Bioservices has a market capitalization of US$1.04b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Avid Bioservices shareholders face the double whammy of a high net debt to EBITDA ratio (7.6), and fairly weak interest coverage, since EBIT is just 1.6 times the interest expense. The debt burden here is substantial. Even worse, Avid Bioservices saw its EBIT tank 78% over the last 12 months. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Avid Bioservices can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Avid Bioservices saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

To be frank both Avid Bioservices's conversion of EBIT to free cash flow and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. Having said that, its ability to handle its total liabilities isn't such a worry. Overall, it seems to us that Avid Bioservices's balance sheet is really quite a risk to the business. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. 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. Be aware that Avid Bioservices is showing 5 warning signs in our investment analysis , and 3 of those are a bit unpleasant...

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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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.