Is Kyongbo Pharmaceutical (KRX:214390) A Risky Investment?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. As with many other companies Kyongbo Pharmaceutical Co., Ltd (KRX:214390) makes use of debt. But should shareholders be worried about its use of debt?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

See our latest analysis for Kyongbo Pharmaceutical

How Much Debt Does Kyongbo Pharmaceutical Carry?

As you can see below, at the end of September 2020, Kyongbo Pharmaceutical had ₩66.8b of debt, up from ₩44.6b a year ago. Click the image for more detail. However, it does have ₩22.2b in cash offsetting this, leading to net debt of about ₩44.6b.

How Healthy Is Kyongbo Pharmaceutical's Balance Sheet?

We can see from the most recent balance sheet that Kyongbo Pharmaceutical had liabilities of ₩100.0b falling due within a year, and liabilities of ₩5.59b due beyond that. Offsetting these obligations, it had cash of ₩22.2b as well as receivables valued at ₩63.9b due within 12 months. So it has liabilities totalling ₩19.5b more than its cash and near-term receivables, combined.

Given Kyongbo Pharmaceutical has a market capitalization of ₩410.0b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Kyongbo Pharmaceutical's net debt is sitting at a very reasonable 2.2 times its EBITDA, while its EBIT covered its interest expense just 5.7 times last year. In large part that's due to the company's significant depreciation and amortisation charges, which arguably mean its EBITDA is a very generous measure of earnings, and its debt may be more of a burden than it first appears. Importantly, Kyongbo Pharmaceutical's EBIT fell a jaw-dropping 36% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. When analysing debt levels, the balance sheet is the obvious place to start. But it is Kyongbo 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, Kyongbo Pharmaceutical created free cash flow amounting to 4.5% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

We'd go so far as to say Kyongbo Pharmaceutical's EBIT growth rate was disappointing. But at least it's pretty decent at staying on top of its total liabilities; that's encouraging. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Kyongbo Pharmaceutical stock a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. 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. For example, we've discovered 4 warning signs for Kyongbo Pharmaceutical (1 is a bit concerning!) that you should be aware of before investing here.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

If you decide to trade Kyongbo 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@simplywallst.com.