We Think DONG AH TIRE & RUBBER (KRX:282690) Can Manage Its Debt With Ease

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. As with many other companies DONG AH TIRE & RUBBER CO., LTD. (KRX:282690) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for DONG AH TIRE & RUBBER

What Is DONG AH TIRE & RUBBER's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 DONG AH TIRE & RUBBER had ₩5.60b of debt, an increase on ₩4.93b, over one year. However, its balance sheet shows it holds ₩44.2b in cash, so it actually has ₩38.6b net cash.

How Healthy Is DONG AH TIRE & RUBBER's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that DONG AH TIRE & RUBBER had liabilities of ₩24.9b due within 12 months and liabilities of ₩1.77b due beyond that. On the other hand, it had cash of ₩44.2b and ₩30.1b worth of receivables due within a year. So it can boast ₩47.7b more liquid assets than total liabilities.

This excess liquidity is a great indication that DONG AH TIRE & RUBBER's balance sheet is almost as strong as Fort Knox. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Succinctly put, DONG AH TIRE & RUBBER boasts net cash, so it's fair to say it does not have a heavy debt load!

But the bad news is that DONG AH TIRE & RUBBER has seen its EBIT plunge 10% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. There's no doubt that we learn most about debt from the balance sheet. But it is DONG AH TIRE & RUBBER's earnings that will influence how the balance sheet holds up in the future. 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. DONG AH TIRE & RUBBER may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last two years, DONG AH TIRE & RUBBER actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that DONG AH TIRE & RUBBER has net cash of ₩38.6b, as well as more liquid assets than liabilities. The cherry on top was that in converted 116% of that EBIT to free cash flow, bringing in ₩16b. So we don't think DONG AH TIRE & RUBBER's use of debt is risky. 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. Be aware that DONG AH TIRE & RUBBER is showing 2 warning signs in our investment analysis , and 1 of those is potentially serious...

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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