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.’ It’s only natural to consider a company’s balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Harvard Bioscience, Inc. (NASDAQ:HBIO) does have debt on its balance sheet. But is this debt a concern to shareholders?
When Is Debt Dangerous?
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 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. The first step when considering a company’s debt levels is to consider its cash and debt together.
What Is Harvard Bioscience’s Net Debt?
As you can see below, Harvard Bioscience had US$55.4m of debt at June 2019, down from US$61.5m a year prior. However, because it has a cash reserve of US$4.93m, its net debt is less, at about US$50.5m.
How Strong Is Harvard Bioscience’s Balance Sheet?
The latest balance sheet data shows that Harvard Bioscience had liabilities of US$20.9m due within a year, and liabilities of US$65.0m falling due after that. On the other hand, it had cash of US$4.93m and US$22.3m worth of receivables due within a year. So it has liabilities totalling US$58.7m more than its cash and near-term receivables, combined.
This is a mountain of leverage relative to its market capitalization of US$95.1m. This suggests shareholders would heavily diluted if the company needed to shore up its balance sheet in a hurry.
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.
While Harvard Bioscience’s debt to EBITDA ratio (4.3) suggests that it uses some debt, its interest cover is very weak, at 0.66, suggesting high leverage. It seems that the business incurs large depreciation and amortisation charges, so maybe its debt load is heavier than it would first appear, since EBITDA is arguably a generous measure of earnings. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. Looking on the bright side, Harvard Bioscience boosted its EBIT by a silky 86% in the last year. Like the milk of human kindness that sort of growth increases resilience, making the company more capable of managing 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 Harvard Bioscience 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.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last two years, Harvard Bioscience generated free cash flow amounting to a very robust 84% of its EBIT, more than we’d expect. That positions it well to pay down debt if desirable to do so.
Based on what we’ve seen Harvard Bioscience is not finding it easy interest cover, but the other factors we considered give us cause to be optimistic. In particular, we are dazzled with its conversion of EBIT to free cash flow. When we consider all the elements mentioned above, it seems to us that Harvard Bioscience is managing its debt quite well. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. Of course, we wouldn’t say no to the extra confidence that we’d gain if we knew that Harvard Bioscience insiders have been buying shares: if you’re on the same wavelength, you can find out if insiders are buying by clicking this link.
When all is said and done, sometimes its easier to focus on companies that don’t even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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