Is Bora Pharmaceuticals (GTSM:6472) A Risky Investment?

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Bora Pharmaceuticals Co., LTD. (GTSM:6472) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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, plenty of companies use debt to fund growth, without any negative consequences. 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 Bora Pharmaceuticals

What Is Bora Pharmaceuticals's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 Bora Pharmaceuticals had NT$2.54b of debt, an increase on NT$1.12b, over one year. However, it does have NT$670.0m in cash offsetting this, leading to net debt of about NT$1.87b.

How Healthy Is Bora Pharmaceuticals' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Bora Pharmaceuticals had liabilities of NT$2.29b due within 12 months and liabilities of NT$2.25b due beyond that. Offsetting these obligations, it had cash of NT$670.0m as well as receivables valued at NT$726.4m due within 12 months. So its liabilities total NT$3.14b more than the combination of its cash and short-term receivables.

Bora Pharmaceuticals has a market capitalization of NT$13.8b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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.

Strangely Bora Pharmaceuticals has a sky high EBITDA ratio of 5.3, implying high debt, but a strong interest coverage of 10.8. This means that unless the company has access to very cheap debt, that interest expense will likely grow in the future. Shareholders should be aware that Bora Pharmaceuticals's EBIT was down 34% last year. 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 ultimately the future profitability of the business will decide if Bora Pharmaceuticals can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Bora Pharmaceuticals saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

On the face of it, Bora Pharmaceuticals's conversion of EBIT to free cash flow left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at covering its interest expense with its EBIT; that's encouraging. Looking at the bigger picture, it seems clear to us that Bora Pharmaceuticals's use of debt is creating risks for the company. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Bora Pharmaceuticals is showing 3 warning signs in our investment analysis , and 1 of those is a bit unpleasant...

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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