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. As with many other companies L&C Bio Co., Ltd (KOSDAQ:290650) makes use of debt. But the more important question is: how much risk is that debt creating?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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.
What Is L&C Bio's Net Debt?
As you can see below, at the end of September 2020, L&C Bio had ₩12.9b of debt, up from ₩1.00b a year ago. Click the image for more detail. However, its balance sheet shows it holds ₩31.4b in cash, so it actually has ₩18.5b net cash.
How Strong Is L&C Bio's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that L&C Bio had liabilities of ₩3.76b due within 12 months and liabilities of ₩15.6b due beyond that. Offsetting this, it had ₩31.4b in cash and ₩9.51b in receivables that were due within 12 months. So it can boast ₩21.6b more liquid assets than total liabilities.
This short term liquidity is a sign that L&C Bio could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, L&C Bio boasts net cash, so it's fair to say it does not have a heavy debt load!
Also good is that L&C Bio grew its EBIT at 17% over the last year, further increasing its ability to manage debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if L&C Bio can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. L&C Bio 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. Looking at the most recent three years, L&C Bio recorded free cash flow of 37% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.
While we empathize with investors who find debt concerning, you should keep in mind that L&C Bio has net cash of ₩18.5b, as well as more liquid assets than liabilities. And we liked the look of last year's 17% year-on-year EBIT growth. So is L&C Bio's debt a risk? It doesn't seem so to us. 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. For example - L&C Bio has 1 warning sign we think you should be aware of.
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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