Is COSMOS Pharmaceutical (TSE:3349) A Risky Investment?

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.’ 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. As with many other companies COSMOS Pharmaceutical Corporation (TSE:3349) makes use of debt. But the real question is whether this debt is making the company risky.

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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. Ultimately, if the company can’t fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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 think about a company’s use of debt, we first look at cash and debt together.

What Is COSMOS Pharmaceutical’s Debt?

The image below, which you can click on for greater detail, shows that at February 2025 COSMOS Pharmaceutical had debt of JP¥28.5b, up from JP¥10.7b in one year. However, it does have JP¥22.8b in cash offsetting this, leading to net debt of about JP¥5.76b.

A Look At COSMOS Pharmaceutical’s Liabilities

The latest balance sheet data shows that COSMOS Pharmaceutical had liabilities of JP¥195.7b due within a year, and liabilities of JP¥29.6b falling due after that. On the other hand, it had cash of JP¥22.8b and JP¥672.0m worth of receivables due within a year. So it has liabilities totalling JP¥201.8b more than its cash and near-term receivables, combined.

This deficit isn’t so bad because COSMOS Pharmaceutical is worth JP¥700.0b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it’s clear that we should definitely closely examine whether it can manage its debt without dilution. But either way, COSMOS Pharmaceutical has virtually no net debt, so it’s fair to say it does not have a heavy debt load!

Check out our latest analysis for COSMOS Pharmaceutical

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).

COSMOS Pharmaceutical’s net debt is only 0.10 times its EBITDA. And its EBIT covers its interest expense a whopping 270 times over. So we’re pretty relaxed about its super-conservative use of debt. Another good sign is that COSMOS Pharmaceutical has been able to increase its EBIT by 23% in twelve months, making it easier to pay down debt. 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 COSMOS 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, 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. Over the last three years, COSMOS Pharmaceutical reported free cash flow worth 5.5% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

Happily, COSMOS Pharmaceutical’s impressive interest cover implies it has the upper hand on its debt. But we must concede we find its conversion of EBIT to free cash flow has the opposite effect. Looking at all the aforementioned factors together, it strikes us that COSMOS Pharmaceutical can handle its debt fairly comfortably. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it’s worth keeping an eye on this one. Over time, share prices tend to follow earnings per share, so if you’re interested in COSMOS Pharmaceutical, you may well want to click here to check an interactive graph of its earnings per share history.

At the end of the day, it’s often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It’s free.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.