Here's Why Daehan New Pharm (KOSDAQ:054670) Can Manage Its Debt Responsibly

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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 Daehan New Pharm Co., Ltd. (KOSDAQ:054670) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

Check out our latest analysis for Daehan New Pharm

What Is Daehan New Pharm's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Daehan New Pharm had ₩40.6b of debt, an increase on ₩35.0b, over one year. However, because it has a cash reserve of ₩23.5b, its net debt is less, at about ₩17.1b.

How Strong Is Daehan New Pharm's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Daehan New Pharm had liabilities of ₩53.3b due within 12 months and liabilities of ₩25.9b due beyond that. Offsetting these obligations, it had cash of ₩23.5b as well as receivables valued at ₩35.1b due within 12 months. So it has liabilities totalling ₩20.5b more than its cash and near-term receivables, combined.

Given Daehan New Pharm has a market capitalization of ₩170.5b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Daehan New Pharm's net debt is only 0.62 times its EBITDA. And its EBIT easily covers its interest expense, being 23.0 times the size. So we're pretty relaxed about its super-conservative use of debt. And we also note warmly that Daehan New Pharm grew its EBIT by 19% last year, making its debt load easier to handle. There's no doubt that we learn most about debt from the balance sheet. But it is Daehan New Pharm'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 company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. Over the most recent two years, Daehan New Pharm recorded free cash flow worth 52% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

Happily, Daehan New Pharm's impressive interest cover implies it has the upper hand on its debt. And the good news does not stop there, as its net debt to EBITDA also supports that impression! Zooming out, Daehan New Pharm seems to use debt quite reasonably; and that gets the nod from us. While debt does bring risk, when used wisely it can also bring a higher return on equity. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Be aware that Daehan New Pharm is showing 1 warning sign in our investment analysis , you should know about...

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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