Is DK&DLtd (KOSDAQ:263020) A Risky Investment?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. As with many other companies DK&D Co.,Ltd (KOSDAQ:263020) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for DK&DLtd

What Is DK&DLtd's Debt?

As you can see below, at the end of September 2020, DK&DLtd had ₩2.83b of debt, up from ₩2.37b a year ago. Click the image for more detail. However, its balance sheet shows it holds ₩15.3b in cash, so it actually has ₩12.4b net cash.

How Healthy Is DK&DLtd's Balance Sheet?

According to the last reported balance sheet, DK&DLtd had liabilities of ₩13.7b due within 12 months, and liabilities of ₩1.38b due beyond 12 months. Offsetting these obligations, it had cash of ₩15.3b as well as receivables valued at ₩12.8b due within 12 months. So it actually has ₩12.9b more liquid assets than total liabilities.

This short term liquidity is a sign that DK&DLtd could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, DK&DLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

Better yet, DK&DLtd grew its EBIT by 127% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. The balance sheet is clearly the area to focus on when you are analysing debt. But it is DK&DLtd'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. DK&DLtd 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, DK&DLtd recorded free cash flow worth 57% 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 DK&DLtd has ₩12.4b in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 127% over the last year. So we don't think DK&DLtd's use of debt is risky. 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. To that end, you should be aware of the 2 warning signs we've spotted with DK&DLtd .

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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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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