Here's Why Ilyang PharmaceuticalLtd (KRX:007570) Can Manage Its Debt Responsibly

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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Ilyang Pharmaceutical Co.,Ltd (KRX:007570) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Ilyang PharmaceuticalLtd

What Is Ilyang PharmaceuticalLtd's Net Debt?

The image below, which you can click on for greater detail, shows that Ilyang PharmaceuticalLtd had debt of ₩128.8b at the end of September 2020, a reduction from ₩140.7b over a year. On the flip side, it has ₩41.7b in cash leading to net debt of about ₩87.2b.

How Healthy Is Ilyang PharmaceuticalLtd's Balance Sheet?

The latest balance sheet data shows that Ilyang PharmaceuticalLtd had liabilities of ₩197.9b due within a year, and liabilities of ₩27.4b falling due after that. On the other hand, it had cash of ₩41.7b and ₩92.2b worth of receivables due within a year. So it has liabilities totalling ₩91.4b more than its cash and near-term receivables, combined.

Since publicly traded Ilyang PharmaceuticalLtd shares are worth a total of ₩1.16t, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Ilyang PharmaceuticalLtd's net debt to EBITDA ratio of about 2.1 suggests only moderate use of debt. And its strong interest cover of 10.7 times, makes us even more comfortable. One way Ilyang PharmaceuticalLtd could vanquish its debt would be if it stops borrowing more but continues to grow EBIT at around 17%, as it did over the last year. 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 Ilyang PharmaceuticalLtd will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. Over the most recent three years, Ilyang PharmaceuticalLtd recorded free cash flow worth 79% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

The good news is that Ilyang PharmaceuticalLtd's demonstrated ability to convert EBIT to free cash flow delights us like a fluffy puppy does a toddler. And that's just the beginning of the good news since its interest cover is also very heartening. Zooming out, Ilyang PharmaceuticalLtd seems to use debt quite reasonably; and that gets the nod from us. After all, sensible leverage can boost returns on equity. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Consider for instance, the ever-present spectre of investment risk. We've identified 2 warning signs with Ilyang PharmaceuticalLtd , and understanding them should be part of your investment process.

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 Ilyang PharmaceuticalLtd, 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 (at) simplywallst.com.