Does Kwang Myung ElectricLtd (KRX:017040) Have A Healthy Balance Sheet?

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.' 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. As with many other companies Kwang Myung Electric Co.,Ltd (KRX:017040) makes use of debt. 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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Kwang Myung ElectricLtd

How Much Debt Does Kwang Myung ElectricLtd Carry?

As you can see below, Kwang Myung ElectricLtd had ₩11.2b of debt at September 2020, down from ₩16.2b a year prior. However, it does have ₩55.2b in cash offsetting this, leading to net cash of ₩44.0b.

How Strong Is Kwang Myung ElectricLtd's Balance Sheet?

We can see from the most recent balance sheet that Kwang Myung ElectricLtd had liabilities of ₩43.6b falling due within a year, and liabilities of ₩6.76b due beyond that. Offsetting this, it had ₩55.2b in cash and ₩11.1b in receivables that were due within 12 months. So it can boast ₩15.9b more liquid assets than total liabilities.

It's good to see that Kwang Myung ElectricLtd has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that Kwang Myung ElectricLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, Kwang Myung ElectricLtd grew its EBIT by 75% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Kwang Myung ElectricLtd 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Kwang Myung ElectricLtd has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Kwang Myung ElectricLtd saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Kwang Myung ElectricLtd has net cash of ₩44.0b, as well as more liquid assets than liabilities. And we liked the look of last year's 75% year-on-year EBIT growth. So we don't think Kwang Myung ElectricLtd's use of debt is risky. 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. Take risks, for example - Kwang Myung ElectricLtd has 2 warning signs we think you should be aware of.

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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