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, SPECO Ltd. (KOSDAQ:013810) does carry debt. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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.
See our latest analysis for SPECO
What Is SPECO's Debt?
As you can see below, at the end of December 2020, SPECO had ₩21.0b of debt, up from ₩19.0b a year ago. Click the image for more detail. But on the other hand it also has ₩21.7b in cash, leading to a ₩773.5m net cash position.
How Strong Is SPECO's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that SPECO had liabilities of ₩45.5b due within 12 months and liabilities of ₩2.23b due beyond that. On the other hand, it had cash of ₩21.7b and ₩16.9b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₩9.12b.
Given SPECO has a market capitalization of ₩161.4b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, SPECO boasts net cash, so it's fair to say it does not have a heavy debt load!
On top of that, SPECO grew its EBIT by 83% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if SPECO can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. SPECO 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. During the last two years, SPECO produced sturdy free cash flow equating to 55% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
Summing up
We could understand if investors are concerned about SPECO's liabilities, but we can be reassured by the fact it has has net cash of ₩773.5m. And we liked the look of last year's 83% year-on-year EBIT growth. So is SPECO's debt a risk? It doesn't seem so to us. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for SPECO you should know about.
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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About KOSDAQ:A013810
SPECO
Manufactures and supplies asphalt plants for use in the road construction in South Korea and internationally.
Adequate balance sheet slight.