Stock Analysis

Here's Why Daelim B&CoLtd (KRX:005750) Has A Meaningful Debt Burden

KOSE:A005750
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Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Daelim B&Co Co.,Ltd. (KRX:005750) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Daelim B&CoLtd

What Is Daelim B&CoLtd's Net Debt?

As you can see below, at the end of September 2020, Daelim B&CoLtd had ₩84.3b of debt, up from ₩68.5b a year ago. Click the image for more detail. On the flip side, it has ₩32.5b in cash leading to net debt of about ₩51.8b.

debt-equity-history-analysis
KOSE:A005750 Debt to Equity History February 14th 2021

A Look At Daelim B&CoLtd's Liabilities

Zooming in on the latest balance sheet data, we can see that Daelim B&CoLtd had liabilities of ₩80.7b due within 12 months and liabilities of ₩91.4b due beyond that. On the other hand, it had cash of ₩32.5b and ₩45.8b worth of receivables due within a year. So its liabilities total ₩93.8b more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of ₩91.4b, we think shareholders really should watch Daelim B&CoLtd's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Daelim B&CoLtd shareholders face the double whammy of a high net debt to EBITDA ratio (6.1), and fairly weak interest coverage, since EBIT is just 0.074 times the interest expense. The debt burden here is substantial. Even worse, Daelim B&CoLtd saw its EBIT tank 97% over the last 12 months. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Daelim B&CoLtd's earnings that will influence how the balance sheet holds up in the future. 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, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Happily for any shareholders, Daelim B&CoLtd actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

To be frank both Daelim B&CoLtd's interest cover and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. But on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. Overall, it seems to us that Daelim B&CoLtd's balance sheet is really quite a risk to the business. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. 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. For example, we've discovered 4 warning signs for Daelim B&CoLtd (2 don't sit too well with us!) that you should be aware of before investing here.

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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