Daewon Cable (KRX:006340) Has A Pretty Healthy Balance Sheet

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. As with many other companies Daewon Cable. Co., Ltd. (KRX:006340) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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.

See our latest analysis for Daewon Cable

What Is Daewon Cable's Debt?

The image below, which you can click on for greater detail, shows that Daewon Cable had debt of ₩20.1b at the end of September 2020, a reduction from ₩35.9b over a year. On the flip side, it has ₩15.1b in cash leading to net debt of about ₩4.91b.

A Look At Daewon Cable's Liabilities

We can see from the most recent balance sheet that Daewon Cable had liabilities of ₩97.1b falling due within a year, and liabilities of ₩13.4b due beyond that. Offsetting this, it had ₩15.1b in cash and ₩96.7b in receivables that were due within 12 months. So these liquid assets roughly match the total liabilities.

Having regard to Daewon Cable's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the ₩101.7b company is short on cash, but still worth keeping an eye on the balance sheet.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). 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).

Daewon Cable has a very low debt to EBITDA ratio of 0.96 so it is strange to see weak interest coverage, with last year's EBIT being only 1.4 times the interest expense. So while we're not necessarily alarmed we think that its debt is far from trivial. Notably, Daewon Cable's EBIT launched higher than Elon Musk, gaining a whopping 695% on last year. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Daewon Cable 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, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Happily for any shareholders, Daewon Cable 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.

Our View

Happily, Daewon Cable's impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. But the stark truth is that we are concerned by its interest cover. Looking at the bigger picture, we think Daewon Cable's use of debt seems quite reasonable and we're not concerned about it. While debt does bring risk, when used wisely it can also bring a higher return on equity. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 4 warning signs for Daewon Cable you should be aware of, and 1 of them can't be ignored.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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