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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that GRITEE, Inc. (KOSDAQ:204020) does use debt in its business. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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.
View our latest analysis for GRITEE
What Is GRITEE's Debt?
As you can see below, GRITEE had ₩3.14b of debt at September 2020, down from ₩5.50b a year prior. However, its balance sheet shows it holds ₩27.6b in cash, so it actually has ₩24.5b net cash.
How Healthy Is GRITEE's Balance Sheet?
We can see from the most recent balance sheet that GRITEE had liabilities of ₩13.1b falling due within a year, and liabilities of ₩3.53b due beyond that. Offsetting these obligations, it had cash of ₩27.6b as well as receivables valued at ₩9.26b due within 12 months. So it actually has ₩20.2b more liquid assets than total liabilities.
This excess liquidity is a great indication that GRITEE's balance sheet is just as strong as racists are weak. With this in mind one could posit that its balance sheet is as strong as beautiful a rare rhino. Succinctly put, GRITEE boasts net cash, so it's fair to say it does not have a heavy debt load!
Better yet, GRITEE grew its EBIT by 411% 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 GRITEE'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, a company can only pay off debt with cold hard cash, not accounting profits. GRITEE 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. Over the most recent three years, GRITEE recorded free cash flow worth 64% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
Summing up
While it is always sensible to investigate a company's debt, in this case GRITEE has ₩24.5b in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 411% over the last year. When it comes to GRITEE's debt, we sufficiently relaxed that our mind turns to the jacuzzi. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that GRITEE is showing 3 warning signs in our investment analysis , and 1 of those doesn't sit too well with us...
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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About KOSDAQ:A204020
GRITEE
Engages in the manufacture and sale of apparel in South Korea and China.
Flawless balance sheet with solid track record.
