These 4 Measures Indicate That Green Cross Medical Science (KOSDAQ:142280) Is Using Debt Extensively

Warren Buffett famously said, '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 can see that Green Cross Medical Science Corporation (KOSDAQ:142280) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Green Cross Medical Science

What Is Green Cross Medical Science's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Green Cross Medical Science had ₩8.64b of debt in September 2020, down from ₩36.2b, one year before. However, because it has a cash reserve of ₩2.05b, its net debt is less, at about ₩6.58b.

How Strong Is Green Cross Medical Science's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Green Cross Medical Science had liabilities of ₩30.7b due within 12 months and liabilities of ₩8.03b due beyond that. Offsetting these obligations, it had cash of ₩2.05b as well as receivables valued at ₩31.7b due within 12 months. So it has liabilities totalling ₩4.96b more than its cash and near-term receivables, combined.

Of course, Green Cross Medical Science has a market capitalization of ₩240.2b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Even though Green Cross Medical Science's debt is only 1.8, its interest cover is really very low at 1.8. The main reason for this is that it has such high depreciation and amortisation. These charges may be non-cash, so they could be excluded when it comes to paying down debt. But the accounting charges are there for a reason -- some assets are seen to be losing value. Either way there's no doubt the stock is using meaningful leverage. We also note that Green Cross Medical Science improved its EBIT from a last year's loss to a positive ₩939m. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Green Cross Medical Science's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. During the last year, Green Cross Medical Science burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Both Green Cross Medical Science's conversion of EBIT to free cash flow and its interest cover were discouraging. At least its level of total liabilities gives us reason to be optimistic. It's also worth noting that Green Cross Medical Science is in the Medical Equipment industry, which is often considered to be quite defensive. Taking the abovementioned factors together we do think Green Cross Medical Science's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. 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. To that end, you should learn about the 3 warning signs we've spotted with Green Cross Medical Science (including 2 which are a bit unpleasant) .

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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