Is CHA Biotech (KOSDAQ:085660) Using Too Much Debt?

The external fund manager backed by Berkshire Hathaway's 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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies CHA Biotech Co., Ltd. (KOSDAQ:085660) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

See our latest analysis for CHA Biotech

What Is CHA Biotech's Net Debt?

As you can see below, at the end of September 2020, CHA Biotech had ₩261.2b of debt, up from ₩189.5b a year ago. Click the image for more detail. However, its balance sheet shows it holds ₩321.7b in cash, so it actually has ₩60.5b net cash.

A Look At CHA Biotech's Liabilities

According to the last reported balance sheet, CHA Biotech had liabilities of ₩259.2b due within 12 months, and liabilities of ₩408.7b due beyond 12 months. Offsetting these obligations, it had cash of ₩321.7b as well as receivables valued at ₩189.1b due within 12 months. So it has liabilities totalling ₩157.2b more than its cash and near-term receivables, combined.

Of course, CHA Biotech has a market capitalization of ₩1.01t, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, CHA Biotech also has more cash than debt, so we're pretty confident it can manage its debt safely.

We also note that CHA Biotech improved its EBIT from a last year's loss to a positive ₩14b. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since CHA Biotech will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. CHA Biotech 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. During the last year, CHA Biotech burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing up

Although CHA Biotech's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of ₩60.5b. So while CHA Biotech does not have a great balance sheet, it's certainly not too bad. Even though CHA Biotech lost money on the bottom line, its positive EBIT suggests the business itself has potential. So you might want to check out how earnings have been trending over the last few years.

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.

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