These 4 metrics indicate that Viva Biotech Holdings (HKG:1873) is making extensive use of debt

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from synonymous with risk.” So it seems smart money knows that debt – which is usually involved in bankruptcies – is a very important factor when you’re assessing a company’s risk. Above all, Viva Biotech Holdings (HKG:1873) is in debt. But the real question is whether this debt makes the business risky.

When is debt dangerous?

Generally speaking, debt only becomes a real problem when a company cannot easily repay it, either by raising capital or with its own cash flow. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more common (but still costly) situation is when a company has to dilute shareholders at a cheap share price just to keep debt under control. Of course, debt can be an important tool in businesses, especially capital-intensive businesses. The first thing to do when considering how much debt a business has is to look at its cash and debt together.

Check out our latest analysis for Viva Biotech Holdings

How much debt does Viva Biotech Holdings have?

You can click on the chart below for historical numbers, but it shows Viva Biotech Holdings had 2.62 trillion yen in debt in December 2021, up from 2.95 trillion yen a year prior. However, he has 800.9 million national yen of cash to offset this, resulting in a net debt of approximately 1.82 billion national yen.

How strong is Viva Biotech Holdings’ balance sheet?

The latest balance sheet data shows that Viva Biotech Holdings had liabilities of 926.6 million yen maturing within one year, and liabilities of 3.20 billion yen maturing thereafter. On the other hand, it had a cash position of 800.9 million Canadian yen and 429.7 million domestic yen of receivables due within one year. Thus, its liabilities total 2.90 billion Canadian yen more than the combination of its cash and short-term receivables.

This deficit is considerable compared to its market capitalization of 4.36 billion Canadian yen, so it suggests that shareholders monitor the use of debt by Viva Biotech Holdings. If its lenders asked it to shore up its balance sheet, shareholders would likely face significant dilution.

We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.

Viva Biotech Holdings shareholders face the double whammy of a high net debt to EBITDA ratio (6.3) and fairly low interest coverage, as EBIT is only 1.5 times interest charges. The debt burden here is considerable. However, shareholders should be reassured to remember that Viva Biotech Holdings has actually increased its EBIT by 105% over the past 12 months. If this earnings trend continues, it will make its leverage much more manageable in the future. There is no doubt that we learn the most about debt from the balance sheet. But ultimately, the company’s future profitability will decide whether Viva Biotech Holdings can strengthen its balance sheet over time. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.

Finally, a company can only repay its debts with cold hard cash, not with book profits. We must therefore clearly examine whether this EBIT generates a corresponding free cash flow. Over the past three years, Viva Biotech Holdings has experienced substantial negative free cash flow, in total. While this may be the result of spending for growth, it makes debt much riskier.

Our point of view

To be frank, Viva Biotech Holdings’ net debt to EBITDA ratio and history of converting EBIT to free cash flow makes us rather uncomfortable with its debt levels. But at least it’s decent enough to increase its EBIT; it’s encouraging. Overall, we think it’s fair to say that Viva Biotech Holdings has enough debt that there are real risks around the balance sheet. If all goes well, this should boost returns, but on the other hand, the risk of permanent capital loss is increased by debt. The balance sheet is clearly the area to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist outside of the balance sheet. These risks can be difficult to spot. Every business has them, and we’ve spotted 2 warning signs for Viva Biotech Holdings (of which 1 is significant!) that you should know.

In the end, it’s often best to focus on companies that aren’t in debt. You can access our special list of these companies (all with a track record of earnings growth). It’s free.

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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.