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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.' 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 Jacobson Pharma Corporation Limited (HKG:2633) makes use of debt. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
See our latest analysis for Jacobson Pharma
How Much Debt Does Jacobson Pharma Carry?
The image below, which you can click on for greater detail, shows that Jacobson Pharma had debt of HK$1.30b at the end of March 2019, a reduction from HK$1.35b over a year. However, because it has a cash reserve of HK$689.3m, its net debt is less, at about HK$607.3m.
How Strong Is Jacobson Pharma's Balance Sheet?
The latest balance sheet data shows that Jacobson Pharma had liabilities of HK$1.05b due within a year, and liabilities of HK$519.1m falling due after that. On the other hand, it had cash of HK$689.3m and HK$219.8m worth of receivables due within a year. So it has liabilities totalling HK$664.4m more than its cash and near-term receivables, combined.
While this might seem like a lot, it is not so bad since Jacobson Pharma has a market capitalization of HK$2.40b, 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). 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).