Is NOVAREXLtd (KOSDAQ:194700) Using Too Much Debt?

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, NOVAREX Co.,Ltd. (KOSDAQ:194700) does carry debt. But the more important question is: how much risk is that debt creating?

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. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for NOVAREXLtd

What Is NOVAREXLtd's Debt?

The image below, which you can click on for greater detail, shows that NOVAREXLtd had debt of ₩17.8b at the end of March 2024, a reduction from ₩42.5b over a year. However, it does have ₩26.6b in cash offsetting this, leading to net cash of ₩8.86b.

How Strong Is NOVAREXLtd's Balance Sheet?

According to the last reported balance sheet, NOVAREXLtd had liabilities of ₩56.7b due within 12 months, and liabilities of ₩2.76b due beyond 12 months. Offsetting these obligations, it had cash of ₩26.6b as well as receivables valued at ₩46.6b due within 12 months. So it can boast ₩13.7b more liquid assets than total liabilities.

This surplus suggests that NOVAREXLtd has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, NOVAREXLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

And we also note warmly that NOVAREXLtd grew its EBIT by 11% last year, making its debt load easier to handle. 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 NOVAREXLtd 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. NOVAREXLtd 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. In the last three years, NOVAREXLtd created free cash flow amounting to 14% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that NOVAREXLtd has net cash of ₩8.86b, as well as more liquid assets than liabilities. On top of that, it increased its EBIT by 11% in the last twelve months. So we are not troubled with NOVAREXLtd's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 1 warning sign for NOVAREXLtd that you should be aware of.

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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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.