Here's Why OK Biotech (TPE:4155) Can Manage Its Debt Responsibly

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 OK Biotech Co., Ltd. (TPE:4155) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. 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.

Check out our latest analysis for OK Biotech

What Is OK Biotech's Debt?

The chart below, which you can click on for greater detail, shows that OK Biotech had NT$497.6m in debt in September 2020; about the same as the year before. However, it does have NT$569.1m in cash offsetting this, leading to net cash of NT$71.5m.

A Look At OK Biotech's Liabilities

Zooming in on the latest balance sheet data, we can see that OK Biotech had liabilities of NT$581.4m due within 12 months and liabilities of NT$284.5m due beyond that. On the other hand, it had cash of NT$569.1m and NT$314.4m worth of receivables due within a year. So it actually has NT$17.7m more liquid assets than total liabilities.

Having regard to OK Biotech's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the NT$2.65b company is short on cash, but still worth keeping an eye on the balance sheet. Simply put, the fact that OK Biotech has more cash than debt is arguably a good indication that it can manage its debt safely.

The good news is that OK Biotech has increased its EBIT by 6.3% over twelve months, which should ease any concerns about debt repayment. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine OK Biotech's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. OK Biotech may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. In the last three years, OK Biotech created free cash flow amounting to 17% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that OK Biotech has net cash of NT$71.5m, as well as more liquid assets than liabilities. And it also grew its EBIT by 6.3% over the last year. So we don't have any problem with OK Biotech's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Take risks, for example - OK Biotech has 3 warning signs we think you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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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