Here's Why A-Jin IndustrialLtd (KOSDAQ:013310) Is Weighed Down By Its Debt Load

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. We note that A-Jin Industrial Co.,Ltd. (KOSDAQ:013310) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. If things get really bad, the lenders can take control of the business. 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, 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. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for A-Jin IndustrialLtd

How Much Debt Does A-Jin IndustrialLtd Carry?

As you can see below, A-Jin IndustrialLtd had ₩280.8b of debt, at September 2020, which is about the same as the year before. You can click the chart for greater detail. However, it also had ₩39.4b in cash, and so its net debt is ₩241.4b.

A Look At A-Jin IndustrialLtd's Liabilities

Zooming in on the latest balance sheet data, we can see that A-Jin IndustrialLtd had liabilities of ₩265.3b due within 12 months and liabilities of ₩205.8b due beyond that. On the other hand, it had cash of ₩39.4b and ₩68.8b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₩363.0b.

The deficiency here weighs heavily on the ₩110.8b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, A-Jin IndustrialLtd would likely require a major re-capitalisation if it had to pay its creditors today.

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).

While A-Jin IndustrialLtd's debt to EBITDA ratio (3.6) suggests that it uses some debt, its interest cover is very weak, at 1.2, suggesting 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. Worse, A-Jin IndustrialLtd's EBIT was down 37% over the last year. 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, A-Jin IndustrialLtd burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

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 even its interest cover fails to inspire much 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. 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. To that end, you should learn about the 3 warning signs we've spotted with A-Jin IndustrialLtd (including 2 which are a bit concerning) .

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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