These 4 Measures Indicate That Englewood Lab (KOSDAQ:950140) Is Using Debt Reasonably Well

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Englewood Lab, Inc. (KOSDAQ:950140) does have debt on its balance sheet. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

See our latest analysis for Englewood Lab

What Is Englewood Lab's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Englewood Lab had ₩27.8b of debt, an increase on ₩25.6b, over one year. However, it also had ₩11.8b in cash, and so its net debt is ₩16.0b.

A Look At Englewood Lab's Liabilities

According to the last reported balance sheet, Englewood Lab had liabilities of ₩43.7b due within 12 months, and liabilities of ₩20.8b due beyond 12 months. Offsetting this, it had ₩11.8b in cash and ₩22.6b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₩30.1b.

While this might seem like a lot, it is not so bad since Englewood Lab has a market capitalization of ₩114.0b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Looking at its net debt to EBITDA of 1.4 and interest cover of 6.4 times, it seems to us that Englewood Lab is probably using debt in a pretty reasonable way. So we'd recommend keeping a close eye on the impact financing costs are having on the business. Better yet, Englewood Lab grew its EBIT by 137% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Englewood Lab's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Happily for any shareholders, Englewood Lab actually produced more free cash flow than EBIT over the last two years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

Happily, Englewood Lab's impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. And that's just the beginning of the good news since its EBIT growth rate is also very heartening. Looking at the bigger picture, we think Englewood Lab's use of debt seems quite reasonable and we're not concerned about it. While debt does bring risk, when used wisely it can also bring a higher return on equity. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Englewood Lab you should know about.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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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