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.' 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. As with many other companies DTR Automotive Corporation (KRX:007340) makes use of debt. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.
What Is DTR Automotive's Net Debt?
You can click the graphic below for the historical numbers, but it shows that DTR Automotive had ₩147.1b of debt in September 2020, down from ₩159.1b, one year before. But on the other hand it also has ₩159.4b in cash, leading to a ₩12.2b net cash position.
A Look At DTR Automotive's Liabilities
We can see from the most recent balance sheet that DTR Automotive had liabilities of ₩280.5b falling due within a year, and liabilities of ₩31.8b due beyond that. Offsetting this, it had ₩159.4b in cash and ₩172.2b in receivables that were due within 12 months. So it can boast ₩19.4b more liquid assets than total liabilities.
This surplus suggests that DTR Automotive has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, DTR Automotive boasts net cash, so it's fair to say it does not have a heavy debt load!
But the bad news is that DTR Automotive has seen its EBIT plunge 16% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. 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 DTR Automotive 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. While DTR Automotive has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, DTR Automotive produced sturdy free cash flow equating to 59% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
While it is always sensible to investigate a company's debt, in this case DTR Automotive has ₩12.2b in net cash and a decent-looking balance sheet. So we don't have any problem with DTR Automotive's use of debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 1 warning sign for DTR Automotive that you should be aware of before investing here.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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