Stock Analysis

Is Orient Precision Industries (KOSDAQ:065500) Using Too Much Debt?

KOSDAQ:A065500
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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 note that Orient Precision Industries Inc (KOSDAQ:065500) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Orient Precision Industries

What Is Orient Precision Industries's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Orient Precision Industries had ₩19.8b of debt in March 2024, down from ₩33.1b, one year before. However, because it has a cash reserve of ₩2.87b, its net debt is less, at about ₩16.9b.

debt-equity-history-analysis
KOSDAQ:A065500 Debt to Equity History June 3rd 2024

How Healthy Is Orient Precision Industries' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Orient Precision Industries had liabilities of ₩41.1b due within 12 months and liabilities of ₩14.6b due beyond that. Offsetting these obligations, it had cash of ₩2.87b as well as receivables valued at ₩23.0b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₩29.8b.

Orient Precision Industries has a market capitalization of ₩53.1b, so it could very likely raise cash to ameliorate 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.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Orient Precision Industries has a debt to EBITDA ratio of 3.3 and its EBIT covered its interest expense 3.6 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. However, the silver lining was that Orient Precision Industries achieved a positive EBIT of ₩2.7b in the last twelve months, an improvement on the prior year's loss. When analysing debt levels, the balance sheet is the obvious place to start. But it is Orient Precision Industries's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Over the last year, Orient Precision Industries recorded free cash flow worth a fulsome 82% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Our View

When it comes to the balance sheet, the standout positive for Orient Precision Industries was the fact that it seems able to convert EBIT to free cash flow confidently. But the other factors we noted above weren't so encouraging. For instance it seems like it has to struggle a bit to cover its interest expense with its EBIT. Looking at all this data makes us feel a little cautious about Orient Precision Industries's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 2 warning signs for Orient Precision Industries that you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.