Is KOREA PHARMA (KOSDAQ:032300) A Risky Investment?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We note that KOREA PHARMA Co., Ltd. (KOSDAQ:032300) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for KOREA PHARMA

What Is KOREA PHARMA's Debt?

The image below, which you can click on for greater detail, shows that KOREA PHARMA had debt of ₩28.4b at the end of June 2024, a reduction from ₩54.1b over a year. However, its balance sheet shows it holds ₩44.0b in cash, so it actually has ₩15.5b net cash.

How Healthy Is KOREA PHARMA's Balance Sheet?

The latest balance sheet data shows that KOREA PHARMA had liabilities of ₩26.8b due within a year, and liabilities of ₩20.9b falling due after that. On the other hand, it had cash of ₩44.0b and ₩14.3b worth of receivables due within a year. So it actually has ₩10.6b more liquid assets than total liabilities.

This short term liquidity is a sign that KOREA PHARMA could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, KOREA PHARMA boasts net cash, so it's fair to say it does not have a heavy debt load!

Shareholders should be aware that KOREA PHARMA's EBIT was down 25% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. There's no doubt that we learn most about debt from the balance sheet. But it is KOREA PHARMA'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. KOREA PHARMA 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. Over the most recent three years, KOREA PHARMA recorded free cash flow worth 68% of its EBIT, which is around normal, given free cash flow excludes interest and tax. 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 KOREA PHARMA has net cash of ₩15.5b, as well as more liquid assets than liabilities. The cherry on top was that in converted 68% of that EBIT to free cash flow, bringing in ₩3.3b. So we don't have any problem with KOREA PHARMA's use of debt. 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. For instance, we've identified 2 warning signs for KOREA PHARMA (1 is a bit concerning) you should be aware of.

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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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.