GnCenergy (KOSDAQ:119850) Has A Pretty Healthy Balance Sheet

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. We note that GnCenergy Co., Ltd (KOSDAQ:119850) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for GnCenergy

How Much Debt Does GnCenergy Carry?

The image below, which you can click on for greater detail, shows that GnCenergy had debt of ₩14.7b at the end of September 2020, a reduction from ₩21.3b over a year. But on the other hand it also has ₩33.7b in cash, leading to a ₩19.0b net cash position.

How Healthy Is GnCenergy's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that GnCenergy had liabilities of ₩36.7b due within 12 months and liabilities of ₩1.09b due beyond that. Offsetting this, it had ₩33.7b in cash and ₩18.2b in receivables that were due within 12 months. So it can boast ₩14.1b more liquid assets than total liabilities.

This short term liquidity is a sign that GnCenergy could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that GnCenergy has more cash than debt is arguably a good indication that it can manage its debt safely.

It is just as well that GnCenergy's load is not too heavy, because its EBIT was down 46% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine GnCenergy's ability to maintain a healthy balance sheet going forward. 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. While GnCenergy 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. Looking at the most recent three years, GnCenergy recorded free cash flow of 27% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that GnCenergy has net cash of ₩19.0b, as well as more liquid assets than liabilities. So we are not troubled with GnCenergy's debt use. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Consider risks, for instance. Every company has them, and we've spotted 3 warning signs for GnCenergy 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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