EXA E&C (KOSDAQ:054940) Seems To Use Debt Quite Sensibly

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, EXA E&C Inc. (KOSDAQ:054940) does carry debt. But is this debt a concern to shareholders?

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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for EXA E&C

What Is EXA E&C's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 EXA E&C had ₩28.7b of debt, an increase on ₩26.6b, over one year. On the flip side, it has ₩23.3b in cash leading to net debt of about ₩5.36b.

How Strong Is EXA E&C's Balance Sheet?

We can see from the most recent balance sheet that EXA E&C had liabilities of ₩73.6b falling due within a year, and liabilities of ₩7.20b due beyond that. Offsetting these obligations, it had cash of ₩23.3b as well as receivables valued at ₩55.5b due within 12 months. So its liabilities total ₩2.00b more than the combination of its cash and short-term receivables.

Since publicly traded EXA E&C shares are worth a total of ₩55.4b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

While EXA E&C's low debt to EBITDA ratio of 0.90 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 3.4 times last year does give us pause. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. We also note that EXA E&C improved its EBIT from a last year's loss to a positive ₩3.7b. When analysing debt levels, the balance sheet is the obvious place to start. But it is EXA E&C'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 company can only pay off debt with cold hard cash, not accounting profits. 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, EXA E&C actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

Happily, EXA E&C's impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. But, on a more sombre note, we are a little concerned by its interest cover. When we consider the range of factors above, it looks like EXA E&C is pretty sensible with its use of debt. While that brings some risk, it can also enhance returns for shareholders. 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 2 warning signs for EXA E&C (1 can't be ignored!) that you should be aware of before investing here.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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