LS ELECTRIC (KRX:010120) Seems To Use Debt Quite Sensibly

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. We note that LS ELECTRIC Co., Ltd. (KRX:010120) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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, 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.

Check out our latest analysis for LS ELECTRIC

How Much Debt Does LS ELECTRIC Carry?

As you can see below, at the end of September 2020, LS ELECTRIC had ₩645.9b of debt, up from ₩548.0b a year ago. Click the image for more detail. However, it does have ₩656.2b in cash offsetting this, leading to net cash of ₩10.2b.

How Healthy Is LS ELECTRIC's Balance Sheet?

The latest balance sheet data shows that LS ELECTRIC had liabilities of ₩616.6b due within a year, and liabilities of ₩536.7b falling due after that. Offsetting this, it had ₩656.2b in cash and ₩450.5b in receivables that were due within 12 months. So it has liabilities totalling ₩46.6b more than its cash and near-term receivables, combined.

Since publicly traded LS ELECTRIC shares are worth a total of ₩1.63t, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, LS ELECTRIC boasts net cash, so it's fair to say it does not have a heavy debt load!

On the other hand, LS ELECTRIC's EBIT dived 13%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if LS ELECTRIC can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. LS ELECTRIC may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, LS ELECTRIC recorded free cash flow worth a fulsome 84% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that LS ELECTRIC has ₩10.2b in net cash. And it impressed us with free cash flow of ₩132b, being 84% of its EBIT. So we don't have any problem with LS ELECTRIC's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that LS ELECTRIC is showing 3 warning signs in our investment analysis , you should know about...

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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