Here's Why Namkwang Engineering & Construction (KRX:001260) Can Manage Its Debt Responsibly

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.' 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 note that Namkwang Engineering & Construction Co., Ltd. (KRX:001260) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Namkwang Engineering & Construction

How Much Debt Does Namkwang Engineering & Construction Carry?

You can click the graphic below for the historical numbers, but it shows that Namkwang Engineering & Construction had ₩9.95b of debt in September 2020, down from ₩29.2b, one year before. However, its balance sheet shows it holds ₩106.2b in cash, so it actually has ₩96.2b net cash.

A Look At Namkwang Engineering & Construction's Liabilities

We can see from the most recent balance sheet that Namkwang Engineering & Construction had liabilities of ₩183.1b falling due within a year, and liabilities of ₩8.67b due beyond that. Offsetting this, it had ₩106.2b in cash and ₩57.6b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₩28.0b.

Namkwang Engineering & Construction has a market capitalization of ₩128.2b, 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. Despite its noteworthy liabilities, Namkwang Engineering & Construction boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Namkwang Engineering & Construction if management cannot prevent a repeat of the 34% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Namkwang Engineering & Construction will need earnings to service that debt. 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. Namkwang Engineering & Construction may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Namkwang Engineering & Construction actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

Although Namkwang Engineering & Construction's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of ₩96.2b. And it impressed us with free cash flow of ₩118b, being 350% of its EBIT. So we are not troubled with Namkwang Engineering & Construction's debt use. 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. For example - Namkwang Engineering & Construction has 1 warning sign we think you should be aware of.

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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