Is ElensysLtd (KOSDAQ:264850) A Risky Investment?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Elensys Co.,Ltd. (KOSDAQ:264850) does use debt in its business. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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.

Check out our latest analysis for ElensysLtd

What Is ElensysLtd's Debt?

The image below, which you can click on for greater detail, shows that ElensysLtd had debt of ₩10.8b at the end of September 2020, a reduction from ₩13.2b over a year. However, it also had ₩7.65b in cash, and so its net debt is ₩3.11b.

How Strong Is ElensysLtd's Balance Sheet?

The latest balance sheet data shows that ElensysLtd had liabilities of ₩14.0b due within a year, and liabilities of ₩6.78b falling due after that. Offsetting these obligations, it had cash of ₩7.65b as well as receivables valued at ₩10.8b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₩2.34b.

Given ElensysLtd has a market capitalization of ₩67.5b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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).

ElensysLtd has a low net debt to EBITDA ratio of only 0.58. And its EBIT easily covers its interest expense, being 31.6 times the size. So we're pretty relaxed about its super-conservative use of debt. On the other hand, ElensysLtd saw its EBIT drop by 4.6% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. When analysing debt levels, the balance sheet is the obvious place to start. But it is ElensysLtd'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's worth checking how much of that EBIT is backed by free cash flow. During the last two years, ElensysLtd burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

ElensysLtd's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered were considerably better. There's no doubt that its ability to to cover its interest expense with its EBIT is pretty flash. Looking at all this data makes us feel a little cautious about ElensysLtd's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that ElensysLtd is showing 5 warning signs in our investment analysis , you should know about...

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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