Is Daebo MagneticLtd (KOSDAQ:290670) A Risky Investment?

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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Daebo Magnetic Co.,Ltd. (KOSDAQ:290670) does carry debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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. 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 Daebo MagneticLtd

What Is Daebo MagneticLtd's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Daebo MagneticLtd had ₩17.2b of debt in September 2020, down from ₩20.2b, one year before. But it also has ₩35.0b in cash to offset that, meaning it has ₩17.9b net cash.

How Strong Is Daebo MagneticLtd's Balance Sheet?

According to the last reported balance sheet, Daebo MagneticLtd had liabilities of ₩25.8b due within 12 months, and liabilities of ₩523.2m due beyond 12 months. On the other hand, it had cash of ₩35.0b and ₩3.88b worth of receivables due within a year. So it actually has ₩12.6b more liquid assets than total liabilities.

This surplus suggests that Daebo MagneticLtd has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Daebo MagneticLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

Importantly, Daebo MagneticLtd's EBIT fell a jaw-dropping 99% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Daebo MagneticLtd'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Daebo MagneticLtd 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. Over the last three years, Daebo MagneticLtd 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.

Summing up

While it is always sensible to investigate a company's debt, in this case Daebo MagneticLtd has ₩17.9b in net cash and a decent-looking balance sheet. Despite its cash we think that Daebo MagneticLtd seems to struggle to grow its EBIT, so we are wary of the stock. 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. We've identified 5 warning signs with Daebo MagneticLtd (at least 3 which are potentially serious) , and understanding them should be part of your investment process.

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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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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