Is Kwang Dong Pharmaceutical (KRX:009290) Using Too Much Debt?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. Importantly, Kwang Dong Pharmaceutical Co., Ltd. (KRX:009290) does carry debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. 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 Kwang Dong Pharmaceutical

How Much Debt Does Kwang Dong Pharmaceutical Carry?

The chart below, which you can click on for greater detail, shows that Kwang Dong Pharmaceutical had ₩108.0b in debt in December 2020; about the same as the year before. However, it does have ₩149.3b in cash offsetting this, leading to net cash of ₩41.3b.

A Look At Kwang Dong Pharmaceutical's Liabilities

We can see from the most recent balance sheet that Kwang Dong Pharmaceutical had liabilities of ₩302.2b falling due within a year, and liabilities of ₩26.3b due beyond that. Offsetting this, it had ₩149.3b in cash and ₩226.0b in receivables that were due within 12 months. So it actually has ₩46.9b more liquid assets than total liabilities.

This surplus suggests that Kwang Dong Pharmaceutical has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Kwang Dong Pharmaceutical boasts net cash, so it's fair to say it does not have a heavy debt load!

And we also note warmly that Kwang Dong Pharmaceutical grew its EBIT by 11% last year, making its debt load easier to handle. There's no doubt that we learn most about debt from the balance sheet. But it is Kwang Dong Pharmaceutical's earnings that will influence how the balance sheet holds up in the future. 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 company can only pay off debt with cold hard cash, not accounting profits. While Kwang Dong Pharmaceutical has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Kwang Dong Pharmaceutical produced sturdy free cash flow equating to 56% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Kwang Dong Pharmaceutical has net cash of ₩41.3b, as well as more liquid assets than liabilities. And it also grew its EBIT by 11% over the last year. So is Kwang Dong Pharmaceutical's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. We've identified 2 warning signs with Kwang Dong Pharmaceutical , 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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