Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 can see that Korea Electric Terminal Co., Ltd. (KRX:025540) does use debt in its business. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, 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.
How Much Debt Does Korea Electric Terminal Carry?
The image below, which you can click on for greater detail, shows that at September 2020 Korea Electric Terminal had debt of ₩12.9b, up from ₩12.2b in one year. However, its balance sheet shows it holds ₩135.7b in cash, so it actually has ₩122.8b net cash.
A Look At Korea Electric Terminal's Liabilities
The latest balance sheet data shows that Korea Electric Terminal had liabilities of ₩133.0b due within a year, and liabilities of ₩58.4b falling due after that. Offsetting these obligations, it had cash of ₩135.7b as well as receivables valued at ₩182.8b due within 12 months. So it actually has ₩127.1b more liquid assets than total liabilities.
This surplus suggests that Korea Electric Terminal is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Succinctly put, Korea Electric Terminal boasts net cash, so it's fair to say it does not have a heavy debt load!
On top of that, Korea Electric Terminal grew its EBIT by 48% 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 Korea Electric Terminal 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Korea Electric Terminal 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, Korea Electric Terminal recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.
While it is always sensible to investigate a company's debt, in this case Korea Electric Terminal has ₩122.8b in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 48% over the last year. So we don't think Korea Electric Terminal's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Like risks, for instance. Every company has them, and we've spotted 2 warning signs for Korea Electric Terminal (of which 1 is concerning!) you should know about.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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