Is Dayou A-TechLtd (KRX:002880) Using Debt In A Risky Way?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. Importantly, Dayou A-Tech Co.,Ltd (KRX:002880) does carry debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 Dayou A-TechLtd

What Is Dayou A-TechLtd's Net Debt?

As you can see below, Dayou A-TechLtd had ₩121.1b of debt at June 2024, down from ₩592.7b a year prior. However, it also had ₩5.50b in cash, and so its net debt is ₩115.6b.

How Healthy Is Dayou A-TechLtd's Balance Sheet?

We can see from the most recent balance sheet that Dayou A-TechLtd had liabilities of ₩289.9b falling due within a year, and liabilities of ₩12.4b due beyond that. Offsetting this, it had ₩5.50b in cash and ₩103.0b in receivables that were due within 12 months. So it has liabilities totalling ₩193.9b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the ₩56.5b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Dayou A-TechLtd would probably need a major re-capitalization if its creditors were to demand repayment. 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 Dayou A-TechLtd 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.

In the last year Dayou A-TechLtd wasn't profitable at an EBIT level, but managed to grow its revenue by 3.1%, to ₩573b. We usually like to see faster growth from unprofitable companies, but each to their own.

Caveat Emptor

Over the last twelve months Dayou A-TechLtd produced an earnings before interest and tax (EBIT) loss. Indeed, it lost a very considerable ₩42b at the EBIT level. If you consider the significant liabilities mentioned above, we are extremely wary of this investment. Of course, it may be able to improve its situation with a bit of luck and good execution. But we think that is unlikely since it is low on liquid assets, and made a loss of ₩1.6b in the last year. So while it's not wise to assume the company will fail, we do think it's risky. 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. We've identified 3 warning signs with Dayou A-TechLtd , and understanding them should be part of your investment process.

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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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.