Here's Why COSMOS Pharmaceutical (TSE:3349) Can Manage Its Debt Responsibly

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. Importantly, COSMOS Pharmaceutical Corporation (TSE:3349) does carry debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for COSMOS Pharmaceutical

What Is COSMOS Pharmaceutical's Debt?

As you can see below, at the end of August 2024, COSMOS Pharmaceutical had JP¥26.8b of debt, up from JP¥12.1b a year ago. Click the image for more detail. But on the other hand it also has JP¥51.4b in cash, leading to a JP¥24.6b net cash position.

How Healthy Is COSMOS Pharmaceutical's Balance Sheet?

According to the last reported balance sheet, COSMOS Pharmaceutical had liabilities of JP¥216.8b due within 12 months, and liabilities of JP¥31.0b due beyond 12 months. On the other hand, it had cash of JP¥51.4b and JP¥658.0m worth of receivables due within a year. So its liabilities total JP¥195.7b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since COSMOS Pharmaceutical has a market capitalization of JP¥513.5b, 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. While it does have liabilities worth noting, COSMOS Pharmaceutical also has more cash than debt, so we're pretty confident it can manage its debt safely.

And we also note warmly that COSMOS Pharmaceutical grew its EBIT by 11% last year, making its debt load easier to handle. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine COSMOS Pharmaceutical's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While COSMOS Pharmaceutical has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Considering the last three years, COSMOS Pharmaceutical actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Summing Up

Although COSMOS Pharmaceutical's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of JP¥24.6b. And it also grew its EBIT by 11% over the last year. So we are not troubled with COSMOS Pharmaceutical's debt use. Over time, share prices tend to follow earnings per share, so if you're interested in COSMOS Pharmaceutical, you may well want to click here to check an interactive graph of its earnings per share history.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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