Dong-Ah Geological Engineering (KRX:028100) Seems To Use Debt Quite Sensibly

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.' 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. As with many other companies Dong-Ah Geological Engineering Company Ltd. (KRX:028100) makes use of debt. But the more important question is: how much risk is that debt creating?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 Dong-Ah Geological Engineering

What Is Dong-Ah Geological Engineering's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Dong-Ah Geological Engineering had ₩74.7b of debt, an increase on ₩67.6b, over one year. But it also has ₩117.0b in cash to offset that, meaning it has ₩42.3b net cash.

How Strong Is Dong-Ah Geological Engineering's Balance Sheet?

The latest balance sheet data shows that Dong-Ah Geological Engineering had liabilities of ₩123.0b due within a year, and liabilities of ₩8.83b falling due after that. Offsetting this, it had ₩117.0b in cash and ₩99.2b in receivables that were due within 12 months. So it actually has ₩84.4b more liquid assets than total liabilities.

This surplus liquidity suggests that Dong-Ah Geological Engineering's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. Having regard to this fact, we think its balance sheet is just as strong as misogynists are weak. Succinctly put, Dong-Ah Geological Engineering boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact Dong-Ah Geological Engineering's saving grace is its low debt levels, because its EBIT has tanked 51% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But it is Dong-Ah Geological Engineering's earnings that will influence how the balance sheet holds up in the future. 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. Dong-Ah Geological Engineering 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. In the last three years, Dong-Ah Geological Engineering created free cash flow amounting to 11% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Dong-Ah Geological Engineering has net cash of ₩42.3b, as well as more liquid assets than liabilities. So we are not troubled with Dong-Ah Geological Engineering's debt use. 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. For instance, we've identified 1 warning sign for Dong-Ah Geological Engineering that you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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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