Is DT&C (KOSDAQ:187220) Using Too Much Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 DT&C Co., Ltd. (KOSDAQ:187220) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for DT&C

What Is DT&C's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2020 DT&C had debt of ₩86.7b, up from ₩68.3b in one year. On the flip side, it has ₩17.8b in cash leading to net debt of about ₩68.9b.

How Strong Is DT&C's Balance Sheet?

According to the last reported balance sheet, DT&C had liabilities of ₩54.5b due within 12 months, and liabilities of ₩49.5b due beyond 12 months. Offsetting these obligations, it had cash of ₩17.8b as well as receivables valued at ₩22.9b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₩63.3b.

This is a mountain of leverage relative to its market capitalization of ₩75.6b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

While we wouldn't worry about DT&C's net debt to EBITDA ratio of 4.2, we think its super-low interest cover of 0.75 times is a sign of high leverage. In large part that's due to the company's significant depreciation and amortisation charges, which arguably mean its EBITDA is a very generous measure of earnings, and its debt may be more of a burden than it first appears. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. One redeeming factor for DT&C is that it turned last year's EBIT loss into a gain of ₩1.8b, over the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since DT&C 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, DT&C saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

To be frank both DT&C's interest cover and its track record of converting EBIT to free cash flow make us rather uncomfortable with its debt levels. Having said that, its ability to grow its EBIT isn't such a worry. Overall, it seems to us that DT&C's balance sheet is really quite a risk to the business. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. 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. For example, we've discovered 3 warning signs for DT&C (2 are concerning!) that you should be aware of before investing here.

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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