We Think Daewon Sanup (KOSDAQ:005710) Can Manage Its Debt With Ease

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 note that Daewon Sanup Co., Ltd (KOSDAQ:005710) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Daewon Sanup

What Is Daewon Sanup's Net Debt?

As you can see below, Daewon Sanup had ₩25.7b of debt at September 2020, down from ₩30.3b a year prior. But it also has ₩184.7b in cash to offset that, meaning it has ₩159.0b net cash.

A Look At Daewon Sanup's Liabilities

We can see from the most recent balance sheet that Daewon Sanup had liabilities of ₩175.8b falling due within a year, and liabilities of ₩36.7b due beyond that. Offsetting this, it had ₩184.7b in cash and ₩146.7b in receivables that were due within 12 months. So it can boast ₩118.9b more liquid assets than total liabilities.

This surplus liquidity suggests that Daewon Sanup's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. With this in mind one could posit that its balance sheet is as strong as beautiful a rare rhino. Simply put, the fact that Daewon Sanup has more cash than debt is arguably a good indication that it can manage its debt safely.

The modesty of its debt load may become crucial for Daewon Sanup if management cannot prevent a repeat of the 58% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Daewon Sanup will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Daewon Sanup has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Daewon Sanup produced sturdy free cash flow equating to 65% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While we empathize with investors who find debt concerning, the bottom line is that Daewon Sanup has net cash of ₩159.0b and plenty of liquid assets. So is Daewon Sanup's debt a risk? It doesn't seem so to us. 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 2 warning signs for Daewon Sanup you should be aware of.

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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