Does Korea Engineering Consultants (KRX:023350) 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. Importantly, Korea Engineering Consultants Corp. (KRX:023350) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Korea Engineering Consultants

What Is Korea Engineering Consultants's Debt?

The image below, which you can click on for greater detail, shows that Korea Engineering Consultants had debt of ₩41.1b at the end of September 2020, a reduction from ₩49.0b over a year. However, its balance sheet shows it holds ₩41.4b in cash, so it actually has ₩266.5m net cash.

How Healthy Is Korea Engineering Consultants' Balance Sheet?

According to the last reported balance sheet, Korea Engineering Consultants had liabilities of ₩135.1b due within 12 months, and liabilities of ₩30.7b due beyond 12 months. On the other hand, it had cash of ₩41.4b and ₩9.53b worth of receivables due within a year. So it has liabilities totalling ₩114.9b more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of ₩79.3b, we think shareholders really should watch Korea Engineering Consultants's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. Given that Korea Engineering Consultants has more cash than debt, we're pretty confident it can handle its debt, despite the fact that it has a lot of liabilities in total.

Notably, Korea Engineering Consultants made a loss at the EBIT level, last year, but improved that to positive EBIT of ₩762m in the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Korea Engineering Consultants 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Korea Engineering Consultants 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 year, Korea Engineering Consultants actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

While Korea Engineering Consultants does have more liabilities than liquid assets, it also has net cash of ₩266.5m. And it impressed us with free cash flow of ₩31b, being 4,009% of its EBIT. So while Korea Engineering Consultants does not have a great balance sheet, it's certainly not too bad. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 3 warning signs for Korea Engineering Consultants (1 doesn't sit too well with us) 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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