We Think Anam ElectronicsLtd (KRX:008700) Can Stay On Top Of Its 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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Anam Electronics Co.,Ltd. (KRX:008700) makes use of debt. But is this debt a concern to shareholders?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Anam ElectronicsLtd

What Is Anam ElectronicsLtd's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 Anam ElectronicsLtd had ₩62.1b of debt, an increase on ₩52.6b, over one year. On the flip side, it has ₩18.3b in cash leading to net debt of about ₩43.8b.

How Healthy Is Anam ElectronicsLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Anam ElectronicsLtd had liabilities of ₩131.3b due within 12 months and liabilities of ₩2.32b due beyond that. Offsetting these obligations, it had cash of ₩18.3b as well as receivables valued at ₩72.9b due within 12 months. So its liabilities total ₩42.4b more than the combination of its cash and short-term receivables.

Since publicly traded Anam ElectronicsLtd shares are worth a total of ₩219.8b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). 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).

Anam ElectronicsLtd has a debt to EBITDA ratio of 3.7 and its EBIT covered its interest expense 4.4 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. The silver lining is that Anam ElectronicsLtd grew its EBIT by 124% last year, which nourishing like the idealism of youth. If that earnings trend continues it will make its debt load much more manageable in the future. There's no doubt that we learn most about debt from the balance sheet. But it is Anam ElectronicsLtd's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last two years, Anam ElectronicsLtd actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

Anam ElectronicsLtd's conversion of EBIT to free cash flow suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But, on a more sombre note, we are a little concerned by its net debt to EBITDA. Taking all this data into account, it seems to us that Anam ElectronicsLtd takes a pretty sensible approach to debt. While that brings some risk, it can also enhance returns for shareholders. 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. Case in point: We've spotted 2 warning signs for Anam ElectronicsLtd you should be aware of, and 1 of them is potentially serious.

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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