Here's Why Cubic Korea (KOSDAQ:021650) Can Manage Its Debt Responsibly

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 note that Cubic Korea Inc. (KOSDAQ:021650) does have debt on its balance sheet. 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 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, 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.

Check out our latest analysis for Cubic Korea

What Is Cubic Korea's Debt?

You can click the graphic below for the historical numbers, but it shows that Cubic Korea had ₩34.5b of debt in September 2020, down from ₩41.3b, one year before. However, because it has a cash reserve of ₩23.8b, its net debt is less, at about ₩10.7b.

A Look At Cubic Korea's Liabilities

The latest balance sheet data shows that Cubic Korea had liabilities of ₩61.1b due within a year, and liabilities of ₩13.6b falling due after that. Offsetting this, it had ₩23.8b in cash and ₩29.6b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₩21.2b.

Cubic Korea has a market capitalization of ₩69.9b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Cubic Korea has a low net debt to EBITDA ratio of only 0.57. And its EBIT covers its interest expense a whopping 12.1 times over. So we're pretty relaxed about its super-conservative use of debt. In addition to that, we're happy to report that Cubic Korea has boosted its EBIT by 81%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But it is Cubic Korea's earnings that will influence how the balance sheet holds up in the future. 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. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Cubic Korea burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Based on what we've seen Cubic Korea is not finding it easy, given its conversion of EBIT to free cash flow, but the other factors we considered give us cause to be optimistic. There's no doubt that its ability to to cover its interest expense with its EBIT is pretty flash. When we consider all the elements mentioned above, it seems to us that Cubic Korea is managing its debt quite well. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. 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. Take risks, for example - Cubic Korea has 2 warning signs we think you should be aware of.

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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