DongKoo Bio & Pharma (KOSDAQ:006620) Has A Pretty Healthy Balance Sheet

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. Importantly, DongKoo Bio & Pharma Co., Ltd. (KOSDAQ:006620) does carry debt. But the more important question is: how much risk is that debt creating?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth 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.

View our latest analysis for DongKoo Bio & Pharma

What Is DongKoo Bio & Pharma's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2024 DongKoo Bio & Pharma had debt of ₩73.9b, up from ₩36.9b in one year. On the flip side, it has ₩33.7b in cash leading to net debt of about ₩40.3b.

A Look At DongKoo Bio & Pharma's Liabilities

The latest balance sheet data shows that DongKoo Bio & Pharma had liabilities of ₩102.8b due within a year, and liabilities of ₩20.2b falling due after that. Offsetting this, it had ₩33.7b in cash and ₩24.8b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₩64.5b.

DongKoo Bio & Pharma has a market capitalization of ₩134.9b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

DongKoo Bio & Pharma's net debt of 1.6 times EBITDA suggests graceful use of debt. And the alluring interest cover (EBIT of 8.2 times interest expense) certainly does not do anything to dispel this impression. In addition to that, we're happy to report that DongKoo Bio & Pharma has boosted its EBIT by 53%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But it is DongKoo Bio & Pharma's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, DongKoo Bio & Pharma saw substantial negative free cash flow, in total. 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

Based on what we've seen DongKoo Bio & Pharma is not finding it easy, given its conversion of EBIT to free cash flow, but the other factors we considered give us cause to be optimistic. There's no doubt that its ability to to grow its EBIT is pretty flash. When we consider all the factors mentioned above, we do feel a bit cautious about DongKoo Bio & Pharma's use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for DongKoo Bio & Pharma you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.