Kwang Dong Pharmaceutical (KRX:009290) Seems To Use Debt Quite Sensibly

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. Importantly, Kwang Dong Pharmaceutical Co., Ltd. (KRX:009290) does carry debt. But is this debt a concern to shareholders?

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. If things get really bad, the lenders can take control of the business. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest 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.

See our latest analysis for Kwang Dong Pharmaceutical

What Is Kwang Dong Pharmaceutical's Debt?

As you can see below, Kwang Dong Pharmaceutical had ₩108.0b of debt, at September 2020, which is about the same as the year before. You can click the chart for greater detail. But it also has ₩166.6b in cash to offset that, meaning it has ₩58.6b net cash.

How Strong Is Kwang Dong Pharmaceutical's Balance Sheet?

According to the last reported balance sheet, Kwang Dong Pharmaceutical had liabilities of ₩288.4b due within 12 months, and liabilities of ₩27.2b due beyond 12 months. Offsetting these obligations, it had cash of ₩166.6b as well as receivables valued at ₩238.1b due within 12 months. So it actually has ₩89.1b more liquid assets than total liabilities.

This excess liquidity suggests that Kwang Dong Pharmaceutical is taking a careful approach to debt. 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 Kwang Dong Pharmaceutical has more cash than debt is arguably a good indication that it can manage its debt safely.

The good news is that Kwang Dong Pharmaceutical has increased its EBIT by 7.1% over twelve months, which should ease any concerns about debt repayment. When analysing debt levels, the balance sheet is the obvious place to start. 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. 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. Looking at the most recent three years, Kwang Dong Pharmaceutical recorded free cash flow of 48% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While it is always sensible to investigate a company's debt, in this case Kwang Dong Pharmaceutical has ₩58.6b in net cash and a decent-looking balance sheet. On top of that, it increased its EBIT by 7.1% in the last twelve months. So is Kwang Dong Pharmaceutical's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 3 warning signs for Kwang Dong Pharmaceutical you should be aware of, and 1 of them makes us a bit uncomfortable.

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. 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.
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