Daesung FinetecLtd (KOSDAQ:104040) Has A Pretty Healthy Balance Sheet

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 Daesung Finetec Co.,Ltd. (KOSDAQ:104040) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Daesung FinetecLtd

What Is Daesung FinetecLtd's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Daesung FinetecLtd had ₩29.2b of debt in September 2020, down from ₩31.8b, one year before. However, because it has a cash reserve of ₩16.6b, its net debt is less, at about ₩12.6b.

How Strong Is Daesung FinetecLtd's Balance Sheet?

The latest balance sheet data shows that Daesung FinetecLtd had liabilities of ₩30.9b due within a year, and liabilities of ₩7.66b falling due after that. Offsetting this, it had ₩16.6b in cash and ₩8.90b in receivables that were due within 12 months. So its liabilities total ₩13.0b more than the combination of its cash and short-term receivables.

Given Daesung FinetecLtd has a market capitalization of ₩69.6b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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 Daesung FinetecLtd's net debt to EBITDA ratio of 4.0, we think its super-low interest cover of 0.86 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. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. One redeeming factor for Daesung FinetecLtd is that it turned last year's EBIT loss into a gain of ₩562m, over the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is Daesung FinetecLtd'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, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, Daesung FinetecLtd actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

Based on what we've seen Daesung FinetecLtd is not finding it easy, given its interest cover, but the other factors we considered give us cause to be optimistic. There's no doubt that its ability to to convert EBIT to free cash flow is pretty flash. Considering this range of data points, we think Daesung FinetecLtd is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. 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. For instance, we've identified 5 warning signs for Daesung FinetecLtd (2 are potentially serious) 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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