Daechang Forging (KRX:015230) Could Easily Take On More 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. We note that Daechang Forging Co., Ltd. (KRX:015230) does have debt on its balance sheet. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Daechang Forging

What Is Daechang Forging's Net Debt?

As you can see below, Daechang Forging had ₩3.02b of debt, at September 2020, which is about the same as the year before. You can click the chart for greater detail. However, it does have ₩71.7b in cash offsetting this, leading to net cash of ₩68.7b.

How Healthy Is Daechang Forging's Balance Sheet?

The latest balance sheet data shows that Daechang Forging had liabilities of ₩34.9b due within a year, and liabilities of ₩16.8b falling due after that. Offsetting this, it had ₩71.7b in cash and ₩41.4b in receivables that were due within 12 months. So it can boast ₩61.4b more liquid assets than total liabilities.

This luscious liquidity implies that Daechang Forging's balance sheet is sturdy like a giant sequoia tree. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Succinctly put, Daechang Forging boasts net cash, so it's fair to say it does not have a heavy debt load!

The good news is that Daechang Forging has increased its EBIT by 6.3% over twelve months, which should ease any concerns about debt repayment. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Daechang Forging 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. Daechang Forging 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. During the last three years, Daechang Forging produced sturdy free cash flow equating to 75% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Daechang Forging has net cash of ₩68.7b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of ₩21b, being 75% of its EBIT. The bottom line is that we do not find Daechang Forging's debt levels at all concerning. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Daechang Forging (of which 1 is a bit concerning!) you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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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