Is Pharma Research Products (KOSDAQ:214450) 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. We note that Pharma Research Products Co., Ltd (KOSDAQ:214450) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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 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 step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Pharma Research Products

How Much Debt Does Pharma Research Products Carry?

The image below, which you can click on for greater detail, shows that at September 2020 Pharma Research Products had debt of ₩33.4b, up from ₩19.4b in one year. However, it does have ₩68.2b in cash offsetting this, leading to net cash of ₩34.9b.

A Look At Pharma Research Products's Liabilities

According to the last reported balance sheet, Pharma Research Products had liabilities of ₩38.3b due within 12 months, and liabilities of ₩22.0b due beyond 12 months. On the other hand, it had cash of ₩68.2b and ₩26.9b worth of receivables due within a year. So it can boast ₩34.9b more liquid assets than total liabilities.

This surplus suggests that Pharma Research Products has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Pharma Research Products has more cash than debt is arguably a good indication that it can manage its debt safely.

Even more impressive was the fact that Pharma Research Products grew its EBIT by 108% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Pharma Research Products's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Pharma Research Products 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. During the last three years, Pharma Research Products burned a lot of cash. 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.

Summing up

While it is always sensible to investigate a company's debt, in this case Pharma Research Products has ₩34.9b in net cash and a decent-looking balance sheet. And we liked the look of last year's 108% year-on-year EBIT growth. So we don't have any problem with Pharma Research Products's use of debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Consider for instance, the ever-present spectre of investment risk. We've identified 1 warning sign with Pharma Research Products , and understanding them should be part of your investment process.

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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