Is UNITEKNOLtd (KOSDAQ:241690) Using Too Much Debt?

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that UNITEKNO Co.,Ltd. (KOSDAQ:241690) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for UNITEKNOLtd

What Is UNITEKNOLtd's Debt?

The image below, which you can click on for greater detail, shows that UNITEKNOLtd had debt of ₩31.4b at the end of June 2020, a reduction from ₩33.0b over a year. However, because it has a cash reserve of ₩16.1b, its net debt is less, at about ₩15.3b.

How Strong Is UNITEKNOLtd's Balance Sheet?

The latest balance sheet data shows that UNITEKNOLtd had liabilities of ₩38.6b due within a year, and liabilities of ₩8.70b falling due after that. On the other hand, it had cash of ₩16.1b and ₩9.32b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₩21.9b.

Of course, UNITEKNOLtd has a market capitalization of ₩126.1b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

UNITEKNOLtd's net debt is sitting at a very reasonable 2.0 times its EBITDA, while its EBIT covered its interest expense just 4.9 times last year. While these numbers do not alarm us, it's worth noting that the cost of the company's debt is having a real impact. Importantly, UNITEKNOLtd's EBIT fell a jaw-dropping 36% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. 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 UNITEKNOLtd 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. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, UNITEKNOLtd 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, UNITEKNOLtd's conversion of EBIT to free cash flow left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. But at least its level of total liabilities is not so bad. Overall, we think it's fair to say that UNITEKNOLtd has enough debt that there are some real risks around the balance sheet. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. 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. To that end, you should learn about the 3 warning signs we've spotted with UNITEKNOLtd (including 1 which is is 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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