We Think Human Stem Cells Institute (MCX:ISKJ) Is Taking Some Risk With Its Debt – Simply Wall St

The external fund manager backed by Berkshire Hathaways Charlie Munger, Li Lu, makes no bones about it when he says The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital. Its only natural to consider a companys balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Public Joint-Stock Company Human Stem Cells Institute (MCX:ISKJ) does use debt in its business. But should shareholders be worried about its use of debt?

Generally speaking, debt only becomes a real problem when a company cant easily pay it off, either by raising capital or with its own cash flow. 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 companys debt levels is to consider its cash and debt together.

See our latest analysis for Human Stem Cells Institute

As you can see below, Human Stem Cells Institute had 377.6m of debt at June 2019, down from 401.9m a year prior. However, because it has a cash reserve of 177.9m, its net debt is less, at about 199.7m.

Zooming in on the latest balance sheet data, we can see that Human Stem Cells Institute had liabilities of 411.1m due within 12 months and liabilities of 756.6m due beyond that. On the other hand, it had cash of 177.9m and 79.7m worth of receivables due within a year. So its liabilities total 910.1m more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of 1.04b, so it does suggest shareholders should keep an eye on Human Stem Cells Institutes use of debt. This suggests shareholders would heavily diluted if the company needed to shore up its balance sheet in a hurry.

We measure a companys debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

While Human Stem Cells Institutes low debt to EBITDA ratio of 0.88 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 5.9 times last year does give us pause. So wed recommend keeping a close eye on the impact financing costs are having on the business. It was also good to see that despite losing money on the EBIT line last year, Human Stem Cells Institute turned things around in the last 12 months, delivering and EBIT of 193m. The balance sheet is clearly the area to focus on when you are analysing debt. But you cant view debt in total isolation; since Human Stem Cells Institute will need earnings to service that debt. So if youre 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 dont cut it. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Over the last year, Human Stem Cells Institute reported free cash flow worth 2.0% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

On the face of it, Human Stem Cells Institutes level of total liabilities left us tentative about the stock, and its conversion of EBIT to free cash flow was no more enticing than the one empty restaurant on the busiest night of the year. But at least its pretty decent at managing its debt, based on its EBITDA,; thats encouraging. Once we consider all the factors above, together, it seems to us that Human Stem Cells Institutes debt is making it a bit risky. Thats not necessarily a bad thing, but wed generally feel more comfortable with less leverage. 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. Consider for instance, the ever-present spectre of investment risk. Weve identified 2 warning signs with Human Stem Cells Institute (at least 1 which shouldnt be ignored) , and understanding them should be part of your investment process.

Of course, if youre the type of investor who prefers buying stocks without the burden of debt, then dont hesitate to discover our exclusive list of net cash growth stocks, today.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.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.

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We Think Human Stem Cells Institute (MCX:ISKJ) Is Taking Some Risk With Its Debt - Simply Wall St