Does NeoPharm (KOSDAQ:092730) Have A Healthy Balance Sheet?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, NeoPharm CO., LTD. (KOSDAQ:092730) does carry debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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. 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.

View our latest analysis for NeoPharm

What Is NeoPharm's Net Debt?

You can click the graphic below for the historical numbers, but it shows that NeoPharm had ₩4.02b of debt in December 2020, down from ₩4.42b, one year before. But on the other hand it also has ₩96.2b in cash, leading to a ₩92.2b net cash position.

How Strong Is NeoPharm's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that NeoPharm had liabilities of ₩14.9b due within 12 months and liabilities of ₩383.6m due beyond that. Offsetting these obligations, it had cash of ₩96.2b as well as receivables valued at ₩8.86b due within 12 months. So it can boast ₩89.8b more liquid assets than total liabilities.

This excess liquidity is a great indication that NeoPharm's balance sheet is almost as strong as Fort Knox. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Simply put, the fact that NeoPharm has more cash than debt is arguably a good indication that it can manage its debt safely.

On the other hand, NeoPharm saw its EBIT drop by 4.6% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if NeoPharm can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. NeoPharm 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 three years, NeoPharm produced sturdy free cash flow equating to 66% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that NeoPharm has net cash of ₩92.2b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of ₩16b, being 66% of its EBIT. So is NeoPharm's debt a risk? It doesn't seem so to us. Over time, share prices tend to follow earnings per share, so if you're interested in NeoPharm, you may well want to click here to check an interactive graph of its earnings per share history.

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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