These 4 Measures Indicate That Anxo Pharmaceutical (GTSM:6677) Is Using Debt Extensively

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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 Anxo Pharmaceutical Co., Ltd. (GTSM:6677) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Anxo Pharmaceutical

What Is Anxo Pharmaceutical's Net Debt?

As you can see below, Anxo Pharmaceutical had NT$900.5m of debt at June 2020, down from NT$952.9m a year prior. However, because it has a cash reserve of NT$221.8m, its net debt is less, at about NT$678.7m.

How Healthy Is Anxo Pharmaceutical's Balance Sheet?

According to the last reported balance sheet, Anxo Pharmaceutical had liabilities of NT$480.0m due within 12 months, and liabilities of NT$677.8m due beyond 12 months. On the other hand, it had cash of NT$221.8m and NT$195.2m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$740.8m.

While this might seem like a lot, it is not so bad since Anxo Pharmaceutical has a market capitalization of NT$1.35b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Anxo Pharmaceutical has a rather high debt to EBITDA ratio of 6.0 which suggests a meaningful debt load. However, its interest coverage of 2.8 is reasonably strong, which is a good sign. On a lighter note, we note that Anxo Pharmaceutical grew its EBIT by 20% in the last year. If it can maintain that kind of improvement, its debt load will begin to melt away like glaciers in a warming world. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Anxo 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. Looking at the most recent three years, Anxo Pharmaceutical recorded free cash flow of 38% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

Anxo Pharmaceutical's net debt to EBITDA was a real negative on this analysis, although the other factors we considered cast it in a significantly better light. For example its EBIT growth rate was refreshing. Taking the abovementioned factors together we do think Anxo Pharmaceutical's debt poses some risks to the business. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 3 warning signs for Anxo Pharmaceutical (1 is a bit unpleasant) you should be aware of.

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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