Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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. We note that BBI Life Sciences Corporation (HKG:1035) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
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. 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 BBI Life Sciences's Debt?
The image below, which you can click on for greater detail, shows that at June 2019 BBI Life Sciences had debt of CN¥74.3m, up from CN¥6.28m in one year. But it also has CN¥155.1m in cash to offset that, meaning it has CN¥80.8m net cash.
A Look At BBI Life Sciences's Liabilities
Zooming in on the latest balance sheet data, we can see that BBI Life Sciences had liabilities of CN¥319.7m due within 12 months and liabilities of CN¥10.5m due beyond that. Offsetting this, it had CN¥155.1m in cash and CN¥186.1m in receivables that were due within 12 months. So it actually has CN¥11.0m more liquid assets than total liabilities.
Having regard to BBI Life Sciences's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the CN¥1.69b company is struggling for cash, we still think it's worth monitoring its balance sheet. Succinctly put, BBI Life Sciences boasts net cash, so it's fair to say it does not have a heavy debt load!
Also good is that BBI Life Sciences grew its EBIT at 17% over the last year, further increasing its ability to manage debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is BBI Life Sciences'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. BBI Life Sciences 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. Over the last three years, BBI Life Sciences saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.
While we empathize with investors who find debt concerning, you should keep in mind that BBI Life Sciences has net cash of CN¥80.8m, as well as more liquid assets than liabilities. And we liked the look of last year's 17% year-on-year EBIT growth. So we are not troubled with BBI Life Sciences's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for BBI Life Sciences you should be aware of, and 1 of them is potentially serious.
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.
If you spot an error that warrants correction, please contact the editor at email@example.com. 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. Simply Wall St has no position in the stocks mentioned.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.