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. Importantly, COWAY Co., Ltd. (KRX:021240) does carry debt. But is this debt a concern to shareholders?
When Is Debt Dangerous?
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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
See our latest analysis for COWAY
How Much Debt Does COWAY Carry?
As you can see below, COWAY had ₩810.0b of debt at September 2020, down from ₩871.2b a year prior. However, it does have ₩227.1b in cash offsetting this, leading to net debt of about ₩583.0b.
How Healthy Is COWAY's Balance Sheet?
According to the last reported balance sheet, COWAY had liabilities of ₩1.49t due within 12 months, and liabilities of ₩159.2b due beyond 12 months. Offsetting these obligations, it had cash of ₩227.1b as well as receivables valued at ₩570.4b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₩855.5b.
Given COWAY has a market capitalization of ₩5.04t, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.
We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
COWAY's net debt is only 0.59 times its EBITDA. And its EBIT covers its interest expense a whopping 25.4 times over. So we're pretty relaxed about its super-conservative use of debt. On the other hand, COWAY saw its EBIT drop by 4.1% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine COWAY's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. Looking at the most recent three years, COWAY recorded free cash flow of 36% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.
Our View
When it comes to the balance sheet, the standout positive for COWAY was the fact that it seems able to cover its interest expense with its EBIT confidently. However, our other observations weren't so heartening. For example, its EBIT growth rate makes us a little nervous about its debt. Considering this range of data points, we think COWAY is in a good position to manage its debt levels. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. 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. For instance, we've identified 1 warning sign for COWAY that you should be aware of.
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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About KOSE:A021240
COWAY
Engages in the production and sale of environmental home appliances in South Korea and internationally.
Solid track record with excellent balance sheet.