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.' 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. We note that STX Corporation (KRX:011810) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
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. 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. 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 STX
What Is STX's Net Debt?
As you can see below, STX had ₩258.5b of debt at September 2020, down from ₩327.6b a year prior. However, because it has a cash reserve of ₩92.4b, its net debt is less, at about ₩166.1b.
How Strong Is STX's Balance Sheet?
We can see from the most recent balance sheet that STX had liabilities of ₩362.5b falling due within a year, and liabilities of ₩44.2b due beyond that. On the other hand, it had cash of ₩92.4b and ₩72.8b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₩241.4b.
This deficit casts a shadow over the ₩111.0b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, STX would likely require a major re-capitalisation if it had to pay its creditors today. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since STX 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.
Over 12 months, STX made a loss at the EBIT level, and saw its revenue drop to ₩1.2t, which is a fall of 20%. To be frank that doesn't bode well.
Caveat Emptor
Not only did STX's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost a very considerable ₩14b at the EBIT level. Considering that alongside the liabilities mentioned above make us nervous about the company. It would need to improve its operations quickly for us to be interested in it. For example, we would not want to see a repeat of last year's loss of ₩17b. And until that time we think this is a risky stock. 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. For example, we've discovered 1 warning sign for STX that you should be aware of before investing here.
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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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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About KOSE:A011810
STX
Engages in energy, commodity, and machinery and engine trading activities in South Korea and internationally.
Adequate balance sheet and slightly overvalued.
