Is Yuhan (KRX:000100) 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.' 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. Importantly, Yuhan Corporation (KRX:000100) does carry debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Yuhan

What Is Yuhan's Net Debt?

As you can see below, at the end of June 2024, Yuhan had ₩261.6b of debt, up from ₩115.9b a year ago. Click the image for more detail. But it also has ₩308.4b in cash to offset that, meaning it has ₩46.8b net cash.

How Healthy Is Yuhan's Balance Sheet?

According to the last reported balance sheet, Yuhan had liabilities of ₩648.6b due within 12 months, and liabilities of ₩121.9b due beyond 12 months. On the other hand, it had cash of ₩308.4b and ₩628.0b worth of receivables due within a year. So it actually has ₩165.9b more liquid assets than total liabilities.

Having regard to Yuhan's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the ₩11t company is struggling for cash, we still think it's worth monitoring its balance sheet. Simply put, the fact that Yuhan has more cash than debt is arguably a good indication that it can manage its debt safely.

It is just as well that Yuhan's load is not too heavy, because its EBIT was down 59% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Yuhan can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Yuhan 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, Yuhan 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 we empathize with investors who find debt concerning, you should keep in mind that Yuhan has net cash of ₩46.8b, as well as more liquid assets than liabilities. So while Yuhan does not have a great balance sheet, it's certainly not too bad. 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. We've identified 1 warning sign with Yuhan , and understanding them should be part of your investment process.

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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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.