Daewoong Pharmaceutical (KRX:069620) Seems To Use Debt Quite Sensibly

Simply Wall St · 10/15 21:17

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Daewoong Pharmaceutical Co., Ltd (KRX:069620) does use debt in its business. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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. 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 Daewoong Pharmaceutical

How Much Debt Does Daewoong Pharmaceutical Carry?

The image below, which you can click on for greater detail, shows that at June 2024 Daewoong Pharmaceutical had debt of ₩548.8b, up from ₩408.5b in one year. On the flip side, it has ₩110.3b in cash leading to net debt of about ₩438.4b.

debt-equity-history-analysis
KOSE:A069620 Debt to Equity History October 15th 2024

How Strong Is Daewoong Pharmaceutical's Balance Sheet?

We can see from the most recent balance sheet that Daewoong Pharmaceutical had liabilities of ₩588.5b falling due within a year, and liabilities of ₩354.1b due beyond that. Offsetting these obligations, it had cash of ₩110.3b as well as receivables valued at ₩214.3b due within 12 months. So its liabilities total ₩617.9b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Daewoong Pharmaceutical has a market capitalization of ₩1.85t, and so it could probably strengthen its balance sheet by raising capital if it needed to. 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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Daewoong Pharmaceutical has a debt to EBITDA ratio of 2.5, which signals significant debt, but is still pretty reasonable for most types of business. However, its interest coverage of 32.1 is very high, suggesting that the interest expense on the debt is currently quite low. One way Daewoong Pharmaceutical could vanquish its debt would be if it stops borrowing more but continues to grow EBIT at around 20%, as it did over the last year. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Daewoong Pharmaceutical can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Daewoong Pharmaceutical 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

Based on what we've seen Daewoong Pharmaceutical is not finding it easy, given its conversion of EBIT to free cash flow, but the other factors we considered give us cause to be optimistic. In particular, we are dazzled with its interest cover. Looking at all this data makes us feel a little cautious about Daewoong Pharmaceutical's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. 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. Case in point: We've spotted 1 warning sign for Daewoong Pharmaceutical you should be aware of.

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.