E-MART (KRX:139480) Seems To Be Using A Lot Of Debt

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 E-MART Inc. (KRX:139480) makes use of 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. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for E-MART

What Is E-MART's Net Debt?

The image below, which you can click on for greater detail, shows that E-MART had debt of ₩819.2b at the end of September 2020, a reduction from ₩4.02t over a year. However, its balance sheet shows it holds ₩1.68t in cash, so it actually has ₩864.2b net cash.

How Strong Is E-MART's Balance Sheet?

The latest balance sheet data shows that E-MART had liabilities of ₩5.97t due within a year, and liabilities of ₩5.90t falling due after that. Offsetting this, it had ₩1.68t in cash and ₩19.7b in receivables that were due within 12 months. So it has liabilities totalling ₩10t more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the ₩4.21t company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. After all, E-MART would likely require a major re-capitalisation if it had to pay its creditors today. Given that E-MART has more cash than debt, we're pretty confident it can handle its debt, despite the fact that it has a lot of liabilities in total.

Shareholders should be aware that E-MART's EBIT was down 39% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine E-MART'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 company can only pay off debt with cold hard cash, not accounting profits. While E-MART 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 three years, E-MART recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Summing up

While E-MART does have more liabilities than liquid assets, it also has net cash of ₩864.2b. However, we do find both E-MART's level of total liabilities and its EBIT growth rate troubling. So even though it has net cash, we do think the business has some risks worth watching. 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. Be aware that E-MART is showing 3 warning signs in our investment analysis , and 1 of those is concerning...

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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