We Think Taeyoung Engineering & ConstructionLtd (KRX:009410) Is Taking Some Risk With 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.' 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. Importantly, Taeyoung Engineering & Construction Co.,Ltd. (KRX:009410) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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 Taeyoung Engineering & ConstructionLtd

What Is Taeyoung Engineering & ConstructionLtd's Net Debt?

The image below, which you can click on for greater detail, shows that Taeyoung Engineering & ConstructionLtd had debt of ₩1.80t at the end of September 2020, a reduction from ₩2.18t over a year. However, because it has a cash reserve of ₩321.8b, its net debt is less, at about ₩1.48t.

How Healthy Is Taeyoung Engineering & ConstructionLtd's Balance Sheet?

The latest balance sheet data shows that Taeyoung Engineering & ConstructionLtd had liabilities of ₩1.72t due within a year, and liabilities of ₩1.41t falling due after that. Offsetting these obligations, it had cash of ₩321.8b as well as receivables valued at ₩677.9b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₩2.13t.

This deficit casts a shadow over the ₩478.4b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Taeyoung Engineering & ConstructionLtd would probably need a major re-capitalization if its creditors were to demand repayment.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Taeyoung Engineering & ConstructionLtd has a debt to EBITDA ratio of 3.1, which signals significant debt, but is still pretty reasonable for most types of business. However, its interest coverage of 11.6 is very high, suggesting that the interest expense on the debt is currently quite low. We note that Taeyoung Engineering & ConstructionLtd grew its EBIT by 24% in the last year, and that should make it easier to pay down debt, going forward. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Taeyoung Engineering & ConstructionLtd 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. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, Taeyoung Engineering & ConstructionLtd basically broke even on a free cash flow basis. Some might say that's a concern, when it comes considering how easily it would be for it to down debt.

Our View

Mulling over Taeyoung Engineering & ConstructionLtd's attempt at staying on top of its total liabilities, we're certainly not enthusiastic. But on the bright side, its interest cover is a good sign, and makes us more optimistic. Looking at the bigger picture, it seems clear to us that Taeyoung Engineering & ConstructionLtd's use of debt is creating risks for the company. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for Taeyoung Engineering & ConstructionLtd that you should be aware of before investing here.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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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