Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, INFAC Corporation (KRX:023810) does carry debt. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.
View our latest analysis for INFAC
How Much Debt Does INFAC Carry?
You can click the graphic below for the historical numbers, but it shows that as of December 2020 INFAC had ₩88.5b of debt, an increase on ₩80.9b, over one year. However, it does have ₩7.33b in cash offsetting this, leading to net debt of about ₩81.2b.
How Strong Is INFAC's Balance Sheet?
The latest balance sheet data shows that INFAC had liabilities of ₩169.3b due within a year, and liabilities of ₩36.0b falling due after that. Offsetting this, it had ₩7.33b in cash and ₩90.2b in receivables that were due within 12 months. So its liabilities total ₩107.8b more than the combination of its cash and short-term receivables.
When you consider that this deficiency exceeds the company's ₩102.0b market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
INFAC's debt is 2.7 times its EBITDA, and its EBIT cover its interest expense 6.6 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Notably, INFAC made a loss at the EBIT level, last year, but improved that to positive EBIT of ₩13b in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since INFAC will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Over the last year, INFAC saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.
Our View
Mulling over INFAC's attempt at converting EBIT to free cash flow, we're certainly not enthusiastic. But at least it's pretty decent at covering its interest expense with its EBIT; that's encouraging. Overall, it seems to us that INFAC's balance sheet is really quite a risk to the business. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example INFAC has 5 warning signs (and 1 which is a bit unpleasant) we think you should know about.
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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About KOSE:A023810
INFAC
Manufactures and sells parts and accessories for motor vehicles in South Korea and internationally.
Slight unattractive dividend payer.