U.S. Markets closed

Here's Why Emergent BioSolutions (NYSE:EBS) Has A Meaningful Debt Burden

Simply Wall St

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.' 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 Emergent BioSolutions Inc. (NYSE:EBS) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. If things get really bad, the lenders can take control of the business. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Emergent BioSolutions

How Much Debt Does Emergent BioSolutions Carry?

As you can see below, at the end of June 2019, Emergent BioSolutions had US$842.1m of debt, up from US$13.5m a year ago. Click the image for more detail. On the flip side, it has US$177.4m in cash leading to net debt of about US$664.7m.

NYSE:EBS Historical Debt, August 14th 2019

How Strong Is Emergent BioSolutions's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Emergent BioSolutions had liabilities of US$301.2m due within 12 months and liabilities of US$1.03b due beyond that. Offsetting these obligations, it had cash of US$177.4m as well as receivables valued at US$218.1m due within 12 months. So its liabilities total US$936.9m more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Emergent BioSolutions has a market capitalization of US$2.25b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

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.

Weak interest cover of 0.68 times and a disturbingly high net debt to EBITDA ratio of 6.0 hit our confidence in Emergent BioSolutions like a one-two punch to the gut. The debt burden here is substantial. Worse, Emergent BioSolutions's EBIT was down 88% over the last year. 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 Emergent BioSolutions 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. In the last three years, Emergent BioSolutions's free cash flow amounted to 45% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

To be frank both Emergent BioSolutions's interest cover and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. Having said that, its ability to convert EBIT to free cash flow isn't such a worry. Overall, it seems to us that Emergent BioSolutions's balance sheet is really quite a risk to the business. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. In light of our reservations about the company's balance sheet, it seems sensible to check if insiders have been selling shares recently.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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.

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. Thank you for reading.