Maeil Holdings (KOSDAQ:005990) Seems To Use Debt Quite Sensibly

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Maeil Holdings Co., Ltd. (KOSDAQ:005990) makes use of debt. But the real question is whether this debt is making the company risky.

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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Maeil Holdings

What Is Maeil Holdings's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Maeil Holdings had ₩124.0b of debt, an increase on ₩115.0b, over one year. However, it does have ₩168.3b in cash offsetting this, leading to net cash of ₩44.3b.

A Look At Maeil Holdings' Liabilities

According to the last reported balance sheet, Maeil Holdings had liabilities of ₩305.7b due within 12 months, and liabilities of ₩123.2b due beyond 12 months. Offsetting these obligations, it had cash of ₩168.3b as well as receivables valued at ₩197.7b due within 12 months. So its liabilities total ₩62.9b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Maeil Holdings is worth ₩112.4b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. Despite its noteworthy liabilities, Maeil Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

Fortunately, Maeil Holdings grew its EBIT by 4.8% in the last year, making that debt load look even more manageable. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Maeil Holdings will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Maeil Holdings 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. In the last three years, Maeil Holdings's free cash flow amounted to 48% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

Although Maeil Holdings's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of ₩44.3b. And it also grew its EBIT by 4.8% over the last year. So we are not troubled with Maeil Holdings's debt use. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 2 warning signs with Maeil Holdings (at least 1 which can't be ignored) , and understanding them should be part of your investment process.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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