Is Castelbajac (KOSDAQ:308100) Using Too Much Debt?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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. Importantly, Castelbajac Co., Ltd. (KOSDAQ:308100) does carry debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Castelbajac

What Is Castelbajac's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Castelbajac had ₩9.31b of debt, an increase on none, over one year. But on the other hand it also has ₩29.8b in cash, leading to a ₩20.5b net cash position.

A Look At Castelbajac's Liabilities

According to the last reported balance sheet, Castelbajac had liabilities of ₩16.2b due within 12 months, and liabilities of ₩12.1b due beyond 12 months. Offsetting these obligations, it had cash of ₩29.8b as well as receivables valued at ₩12.9b due within 12 months. So it can boast ₩14.4b more liquid assets than total liabilities.

It's good to see that Castelbajac has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that Castelbajac has more cash than debt is arguably a good indication that it can manage its debt safely.

The modesty of its debt load may become crucial for Castelbajac if management cannot prevent a repeat of the 50% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Castelbajac can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Castelbajac has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last two years, Castelbajac reported free cash flow worth 15% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Castelbajac has net cash of ₩20.5b, as well as more liquid assets than liabilities. So we don't have any problem with Castelbajac's use of debt. 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. Like risks, for instance. Every company has them, and we've spotted 4 warning signs for Castelbajac (of which 1 is potentially serious!) you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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