These 4 Measures Indicate That Celltrion Pharm (KOSDAQ:068760) Is Using Debt Reasonably Well

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Celltrion Pharm, Inc. (KOSDAQ:068760) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Celltrion Pharm

What Is Celltrion Pharm's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Celltrion Pharm had ₩191.2b of debt, an increase on ₩153.9b, over one year. On the flip side, it has ₩24.8b in cash leading to net debt of about ₩166.4b.

A Look At Celltrion Pharm's Liabilities

We can see from the most recent balance sheet that Celltrion Pharm had liabilities of ₩178.7b falling due within a year, and liabilities of ₩59.6b due beyond that. On the other hand, it had cash of ₩24.8b and ₩141.3b worth of receivables due within a year. So it has liabilities totalling ₩72.2b more than its cash and near-term receivables, combined.

Having regard to Celltrion Pharm's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the ₩6.83t company is short on cash, but still worth keeping an eye on the balance sheet.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Celltrion Pharm has a debt to EBITDA ratio of 4.8 and its EBIT covered its interest expense 4.8 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Importantly, Celltrion Pharm grew its EBIT by 55% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Celltrion Pharm will need earnings to service that debt. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Celltrion Pharm 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

Celltrion Pharm's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered were considerably better. 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 Celltrion Pharm's use of debt. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Celltrion Pharm (of which 1 shouldn't be ignored!) you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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