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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that GS Holdings Corp. (KRX:078930) does have debt on its balance sheet. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
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. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. 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 GS Holdings
How Much Debt Does GS Holdings Carry?
As you can see below, GS Holdings had ₩8.56t of debt, at December 2020, which is about the same as the year before. You can click the chart for greater detail. However, because it has a cash reserve of ₩1.81t, its net debt is less, at about ₩6.75t.
A Look At GS Holdings' Liabilities
The latest balance sheet data shows that GS Holdings had liabilities of ₩4.00t due within a year, and liabilities of ₩9.72t falling due after that. Offsetting this, it had ₩1.81t in cash and ₩1.05t in receivables that were due within 12 months. So its liabilities total ₩11t more than the combination of its cash and short-term receivables.
This deficit casts a shadow over the ₩3.69t company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, GS Holdings would likely require a major re-capitalisation if it had to pay its creditors today.
In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). 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).
GS Holdings's debt is 3.7 times its EBITDA, and its EBIT cover its interest expense 5.3 times over. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. Importantly, GS Holdings's EBIT fell a jaw-dropping 40% in the last twelve months. 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 ultimately the future profitability of the business will decide if GS Holdings can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, GS Holdings's free cash flow amounted to 45% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.
Our View
To be frank both GS Holdings's EBIT growth rate and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But at least its interest cover is not so bad. Taking into account all the aforementioned factors, it looks like GS Holdings has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. 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 example, we've discovered 2 warning signs for GS Holdings (1 makes us a bit uncomfortable!) that you should be aware of before investing here.
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:A078930
GS Holdings
Together its subsidiaries, engages in the energy, power generation, retail, service, construction, and infrastructure businesses.
Very undervalued with adequate balance sheet and pays a dividend.