Is Dongwha Pharm.Co.Ltd (KRX:000020) Using Too Much Debt?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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 Dongwha Pharm.Co.,Ltd (KRX:000020) 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 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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Dongwha Pharm.Co.Ltd

What Is Dongwha Pharm.Co.Ltd's Net Debt?

As you can see below, at the end of September 2020, Dongwha Pharm.Co.Ltd had ₩9.80b of debt, up from none a year ago. Click the image for more detail. But on the other hand it also has ₩136.2b in cash, leading to a ₩126.4b net cash position.

How Strong Is Dongwha Pharm.Co.Ltd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Dongwha Pharm.Co.Ltd had liabilities of ₩67.4b due within 12 months and liabilities of ₩23.7b due beyond that. Offsetting this, it had ₩136.2b in cash and ₩69.5b in receivables that were due within 12 months. So it actually has ₩114.6b more liquid assets than total liabilities.

It's good to see that Dongwha Pharm.Co.Ltd has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that Dongwha Pharm.Co.Ltd has more cash than debt is arguably a good indication that it can manage its debt safely.

Even more impressive was the fact that Dongwha Pharm.Co.Ltd grew its EBIT by 332% 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 you can't view debt in total isolation; since Dongwha Pharm.Co.Ltd 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Dongwha Pharm.Co.Ltd 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, Dongwha Pharm.Co.Ltd recorded free cash flow worth 64% 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 Dongwha Pharm.Co.Ltd has net cash of ₩126.4b, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 332% over the last year. So is Dongwha Pharm.Co.Ltd'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. Take risks, for example - Dongwha Pharm.Co.Ltd has 3 warning signs (and 1 which shouldn't be ignored) we think you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

If you’re looking to trade Dongwha Pharm.Co.Ltd, open an account with the lowest-cost* platform trusted by professionals, Interactive Brokers. Their clients from over 200 countries and territories trade stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted

This article by Simply Wall St is general in nature. 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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com.