Does DAEMO Engineering (KOSDAQ:317850) Have A Healthy Balance Sheet?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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, DAEMO Engineering Co., Ltd. (KOSDAQ:317850) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for DAEMO Engineering

What Is DAEMO Engineering's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 DAEMO Engineering had ₩26.8b of debt, an increase on ₩18.4b, over one year. However, it does have ₩13.5b in cash offsetting this, leading to net debt of about ₩13.3b.

A Look At DAEMO Engineering's Liabilities

We can see from the most recent balance sheet that DAEMO Engineering had liabilities of ₩11.9b falling due within a year, and liabilities of ₩21.2b due beyond that. On the other hand, it had cash of ₩13.5b and ₩5.93b worth of receivables due within a year. So it has liabilities totalling ₩13.6b more than its cash and near-term receivables, combined.

DAEMO Engineering has a market capitalization of ₩36.7b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). 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).

DAEMO Engineering shareholders face the double whammy of a high net debt to EBITDA ratio (7.5), and fairly weak interest coverage, since EBIT is just 0.98 times the interest expense. This means we'd consider it to have a heavy debt load. Even worse, DAEMO Engineering saw its EBIT tank 80% over the last 12 months. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is DAEMO Engineering'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, DAEMO Engineering 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

To be frank both DAEMO Engineering's conversion of EBIT to free cash flow and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. But at least its level of total liabilities is not so bad. Taking into account all the aforementioned factors, it looks like DAEMO Engineering has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. 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. Be aware that DAEMO Engineering is showing 6 warning signs in our investment analysis , and 2 of those are concerning...

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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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