These 4 Measures Indicate That Dohwa Engineering (KRX:002150) Is Using Debt Reasonably Well

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Dohwa Engineering Co., Ltd. (KRX:002150) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Dohwa Engineering

How Much Debt Does Dohwa Engineering Carry?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 Dohwa Engineering had ₩24.8b of debt, an increase on ₩3.79b, over one year. However, it does have ₩75.6b in cash offsetting this, leading to net cash of ₩50.8b.

How Healthy Is Dohwa Engineering's Balance Sheet?

We can see from the most recent balance sheet that Dohwa Engineering had liabilities of ₩162.4b falling due within a year, and liabilities of ₩32.5b due beyond that. On the other hand, it had cash of ₩75.6b and ₩108.7b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₩10.5b.

Given Dohwa Engineering has a market capitalization of ₩273.4b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Dohwa Engineering also has more cash than debt, so we're pretty confident it can manage its debt safely.

But the bad news is that Dohwa Engineering has seen its EBIT plunge 11% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Dohwa Engineering's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Dohwa Engineering 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 most recent three years, Dohwa Engineering recorded free cash flow worth 75% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing up

We could understand if investors are concerned about Dohwa Engineering's liabilities, but we can be reassured by the fact it has has net cash of ₩50.8b. And it impressed us with free cash flow of -₩11b, being 75% of its EBIT. So we are not troubled with Dohwa Engineering's debt use. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. We've identified 1 warning sign with Dohwa Engineering , and understanding them should be part of your investment process.

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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