These 4 Measures Indicate That NK (KRX:085310) Is Using Debt Reasonably Well

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. We can see that NK Co., Ltd. (KRX:085310) does use debt in its business. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. 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 NK

What Is NK's Net Debt?

You can click the graphic below for the historical numbers, but it shows that NK had ₩19.4b of debt in September 2020, down from ₩36.3b, one year before. However, its balance sheet shows it holds ₩40.6b in cash, so it actually has ₩21.2b net cash.

How Healthy Is NK's Balance Sheet?

We can see from the most recent balance sheet that NK had liabilities of ₩43.1b falling due within a year, and liabilities of ₩6.94b due beyond that. Offsetting these obligations, it had cash of ₩40.6b as well as receivables valued at ₩18.5b due within 12 months. So it actually has ₩9.05b more liquid assets than total liabilities.

This surplus suggests that NK has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that NK has more cash than debt is arguably a good indication that it can manage its debt safely.

Notably, NK made a loss at the EBIT level, last year, but improved that to positive EBIT of ₩1.5b in the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is NK'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. NK 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 year, NK 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 it is always sensible to investigate a company's debt, in this case NK has ₩21.2b in net cash and a decent-looking balance sheet. So we are not troubled with NK's debt use. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example NK has 2 warning signs (and 1 which makes us a bit uncomfortable) we think 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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