We Think Namkwang Engineering & Construction (KRX:001260) Can Stay On Top Of Its Debt

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. Importantly, Namkwang Engineering & Construction Co., Ltd. (KRX:001260) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. 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.

View our latest analysis for Namkwang Engineering & Construction

What Is Namkwang Engineering & Construction's Debt?

As you can see below, Namkwang Engineering & Construction had ₩9.95b of debt at September 2020, down from ₩29.2b a year prior. But on the other hand it also has ₩106.2b in cash, leading to a ₩96.2b net cash position.

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. On the other hand, it had cash of ₩106.2b and ₩57.6b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₩28.0b.

While this might seem like a lot, it is not so bad since Namkwang Engineering & Construction has a market capitalization of ₩99.7b, 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. While it does have liabilities worth noting, Namkwang Engineering & Construction also has more cash than debt, so we're pretty confident it can manage its debt safely.

It is just as well that Namkwang Engineering & Construction's load is not too heavy, because its EBIT was down 34% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Namkwang Engineering & Construction 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Namkwang Engineering & Construction 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. Happily for any shareholders, Namkwang Engineering & Construction actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While Namkwang Engineering & Construction does have more liabilities than liquid assets, it also has net cash of ₩96.2b. The cherry on top was that in converted 350% of that EBIT to free cash flow, bringing in ₩118b. 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. To that end, you should be aware of the 1 warning sign we've spotted with Namkwang Engineering & Construction .

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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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