A-Jin IndustrialLtd (KOSDAQ:013310) Has No Shortage Of Debt

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.' 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. We can see that A-Jin Industrial Co.,Ltd. (KOSDAQ:013310) does use debt in its business. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for A-Jin IndustrialLtd

What Is A-Jin IndustrialLtd's Net Debt?

The chart below, which you can click on for greater detail, shows that A-Jin IndustrialLtd had ₩290.6b in debt in December 2020; about the same as the year before. However, it does have ₩41.3b in cash offsetting this, leading to net debt of about ₩249.3b.

How Strong Is A-Jin IndustrialLtd's Balance Sheet?

We can see from the most recent balance sheet that A-Jin IndustrialLtd had liabilities of ₩221.4b falling due within a year, and liabilities of ₩205.1b due beyond that. Offsetting these obligations, it had cash of ₩41.3b as well as receivables valued at ₩66.3b due within 12 months. So its liabilities total ₩318.9b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the ₩148.0b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, A-Jin IndustrialLtd would likely require a major re-capitalisation if it had to pay its creditors today.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

While we wouldn't worry about A-Jin IndustrialLtd's net debt to EBITDA ratio of 3.4, we think its super-low interest cover of 1.6 times is a sign of high leverage. It seems that the business incurs large depreciation and amortisation charges, so maybe its debt load is heavier than it would first appear, since EBITDA is arguably a generous measure of earnings. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. Even worse, A-Jin IndustrialLtd saw its EBIT tank 31% over the last 12 months. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since A-Jin IndustrialLtd 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, A-Jin IndustrialLtd recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Our View

On the face of it, A-Jin IndustrialLtd's EBIT growth rate left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. And furthermore, its conversion of EBIT to free cash flow also fails to instill confidence. It looks to us like A-Jin IndustrialLtd carries a significant balance sheet burden. If you play with fire you risk getting burnt, so we'd probably give this stock a wide berth. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 3 warning signs we've spotted with A-Jin IndustrialLtd (including 2 which are a bit unpleasant) .

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. 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.
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