Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. As with many other companies Daehan Flour Mills Co.,Ltd (KRX:001130) 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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.
View our latest analysis for Daehan Flour MillsLtd
What Is Daehan Flour MillsLtd's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of September 2020 Daehan Flour MillsLtd had ₩172.3b of debt, an increase on ₩98.0b, over one year. But on the other hand it also has ₩202.0b in cash, leading to a ₩29.7b net cash position.
How Strong Is Daehan Flour MillsLtd's Balance Sheet?
According to the last reported balance sheet, Daehan Flour MillsLtd had liabilities of ₩230.1b due within 12 months, and liabilities of ₩76.9b due beyond 12 months. Offsetting these obligations, it had cash of ₩202.0b as well as receivables valued at ₩9.16b due within 12 months. So it has liabilities totalling ₩95.8b more than its cash and near-term receivables, combined.
This deficit isn't so bad because Daehan Flour MillsLtd is worth ₩243.5b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, Daehan Flour MillsLtd boasts net cash, so it's fair to say it does not have a heavy debt load!
Also good is that Daehan Flour MillsLtd grew its EBIT at 18% over the last year, further increasing its ability to manage debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Daehan Flour MillsLtd's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Daehan Flour MillsLtd 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. During the last three years, Daehan Flour MillsLtd burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.
Summing up
Although Daehan Flour MillsLtd's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of ₩29.7b. And it impressed us with its EBIT growth of 18% over the last year. So we don't have any problem with Daehan Flour MillsLtd's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for Daehan Flour MillsLtd (1 is significant!) that you should be aware of before investing here.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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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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About KOSE:A001130
Solid track record with excellent balance sheet.
