These 4 Measures Indicate That DRB Holding (KRX:004840) Is Using Debt Extensively

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that DRB Holding Co., Ltd. (KRX:004840) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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. 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, 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 think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for DRB Holding

How Much Debt Does DRB Holding Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 DRB Holding had ₩217.8b of debt, an increase on ₩170.7b, over one year. However, it also had ₩180.4b in cash, and so its net debt is ₩37.4b.

A Look At DRB Holding's Liabilities

We can see from the most recent balance sheet that DRB Holding had liabilities of ₩253.0b falling due within a year, and liabilities of ₩75.8b due beyond that. On the other hand, it had cash of ₩180.4b and ₩98.0b worth of receivables due within a year. So it has liabilities totalling ₩50.5b more than its cash and near-term receivables, combined.

DRB Holding has a market capitalization of ₩128.2b, 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.

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.

Looking at its net debt to EBITDA of 0.87 and interest cover of 4.4 times, it seems to us that DRB Holding is probably using debt in a pretty reasonable way. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. Sadly, DRB Holding's EBIT actually dropped 5.2% in the last year. If earnings continue on that decline then managing that debt will be difficult like delivering hot soup on a unicycle. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since DRB Holding 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, DRB Holding reported free cash flow worth 7.8% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

DRB Holding's struggle to convert EBIT to free cash flow had us second guessing its balance sheet strength, but the other data-points we considered were relatively redeeming. But on the bright side, its ability to handle its debt, based on its EBITDA, isn't too shabby at all. Taking the abovementioned factors together we do think DRB Holding's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. 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 example, we've discovered 5 warning signs for DRB Holding (1 is concerning!) that you should be aware of before investing here.

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. 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.
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