REYON Pharmaceutical (KRX:102460) Seems To Use Debt Quite Sensibly

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.' 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. As with many other companies REYON Pharmaceutical Co., Ltd. (KRX:102460) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for REYON Pharmaceutical

How Much Debt Does REYON Pharmaceutical Carry?

The image below, which you can click on for greater detail, shows that at September 2020 REYON Pharmaceutical had debt of ₩47.6b, up from ₩18.1b in one year. On the flip side, it has ₩44.6b in cash leading to net debt of about ₩3.02b.

A Look At REYON Pharmaceutical's Liabilities

According to the last reported balance sheet, REYON Pharmaceutical had liabilities of ₩44.6b due within 12 months, and liabilities of ₩27.8b due beyond 12 months. Offsetting these obligations, it had cash of ₩44.6b as well as receivables valued at ₩42.2b due within 12 months. So it actually has ₩14.4b more liquid assets than total liabilities.

This surplus suggests that REYON Pharmaceutical has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Carrying virtually no net debt, REYON Pharmaceutical has a very light debt load indeed.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

REYON Pharmaceutical has net debt of just 0.36 times EBITDA, suggesting it could ramp leverage without breaking a sweat. And remarkably, despite having net debt, it actually received more in interest over the last twelve months than it had to pay. So it's fair to say it can handle debt like a hotshot teppanyaki chef handles cooking. Fortunately, REYON Pharmaceutical grew its EBIT by 10.0% in the last year, making that debt load look even more manageable. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since REYON Pharmaceutical 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, REYON Pharmaceutical burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

REYON Pharmaceutical's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered were considerably better. There's no doubt that its ability to to cover its interest expense with its EBIT is pretty flash. When we consider all the elements mentioned above, it seems to us that REYON Pharmaceutical is managing its debt quite well. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. 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. Like risks, for instance. Every company has them, and we've spotted 4 warning signs for REYON Pharmaceutical (of which 2 are concerning!) you should know about.

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.

If you decide to trade REYON Pharmaceutical, use the lowest-cost* platform that is rated #1 Overall by Barron’s, Interactive Brokers. Trade stocks, options, futures, forex, bonds and funds on 135 markets, all 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.