People & Technology (KOSDAQ:137400) Has A Pretty Healthy Balance Sheet

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 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. We note that People & Technology Inc. (KOSDAQ:137400) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. 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. 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.

View our latest analysis for People & Technology

How Much Debt Does People & Technology Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 People & Technology had ₩62.9b of debt, an increase on ₩57.2b, over one year. However, it also had ₩22.8b in cash, and so its net debt is ₩40.1b.

How Strong Is People & Technology's Balance Sheet?

We can see from the most recent balance sheet that People & Technology had liabilities of ₩331.8b falling due within a year, and liabilities of ₩33.8b due beyond that. Offsetting these obligations, it had cash of ₩22.8b as well as receivables valued at ₩34.8b due within 12 months. So its liabilities total ₩308.0b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since People & Technology has a market capitalization of ₩597.7b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without 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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

People & Technology's net debt of 1.8 times EBITDA suggests graceful use of debt. And the alluring interest cover (EBIT of 9.7 times interest expense) certainly does not do anything to dispel this impression. It is well worth noting that People & Technology's EBIT shot up like bamboo after rain, gaining 76% in the last twelve months. That'll make it easier to manage its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since People & Technology 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, People & Technology saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Based on what we've seen People & Technology is not finding it easy, given its conversion of EBIT to free cash flow, but the other factors we considered give us cause to be optimistic. There's no doubt that its ability to to grow its EBIT is pretty flash. When we consider all the factors mentioned above, we do feel a bit cautious about People & Technology's use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. 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. Take risks, for example - People & Technology has 4 warning signs (and 2 which shouldn't be ignored) we think you should know about.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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