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.' 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 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?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Dong-Ah Geological Engineering

What Is Dong-Ah Geological Engineering's Debt?

As you can see below, at the end of December 2020, Dong-Ah Geological Engineering had ₩80.2b of debt, up from ₩61.2b a year ago. Click the image for more detail. However, it does have ₩125.5b in cash offsetting this, leading to net cash of ₩45.3b.

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

The latest balance sheet data shows that Dong-Ah Geological Engineering had liabilities of ₩136.0b due within a year, and liabilities of ₩7.34b falling due after that. On the other hand, it had cash of ₩125.5b and ₩102.3b worth of receivables due within a year. So it can boast ₩84.5b more liquid assets than total liabilities.

This excess liquidity is a great indication that Dong-Ah Geological Engineering's balance sheet is almost as strong as Fort Knox. With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Simply put, the fact that Dong-Ah Geological Engineering has more cash than debt is arguably a good indication that it can manage its debt safely.

The modesty of its debt load may become crucial for Dong-Ah Geological Engineering if management cannot prevent a repeat of the 86% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Dong-Ah Geological Engineering 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. While Dong-Ah Geological Engineering 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. Considering the last three years, Dong-Ah Geological Engineering actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

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 ₩45.3b, as well as more liquid assets than liabilities. So we don't have any problem with Dong-Ah Geological Engineering's use of debt. 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. Case in point: We've spotted 3 warning signs for Dong-Ah Geological Engineering you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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