These 4 Measures Indicate That Daehan Flour MillsLtd (KRX:001130) Is Using Debt Reasonably Well

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.' 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. We note that Daehan Flour Mills Co.,Ltd (KRX:001130) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Daehan Flour MillsLtd

What Is Daehan Flour MillsLtd's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2020 Daehan Flour MillsLtd had debt of ₩172.3b, up from ₩98.0b in one year. However, it does have ₩202.0b in cash offsetting this, leading to net cash of ₩29.7b.

A Look At Daehan Flour MillsLtd's Liabilities

The latest balance sheet data shows that Daehan Flour MillsLtd had liabilities of ₩230.1b due within a year, and liabilities of ₩76.9b falling due after that. On the other hand, it had cash of ₩202.0b and ₩9.16b worth of receivables due within a year. So its liabilities total ₩95.8b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Daehan Flour MillsLtd is worth ₩257.5b, 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, Daehan Flour MillsLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

And we also note warmly that Daehan Flour MillsLtd grew its EBIT by 18% last year, making its debt load easier to handle. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Daehan Flour MillsLtd will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Daehan Flour MillsLtd may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Daehan Flour MillsLtd saw substantial negative free cash flow, in total. 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 we liked the look of last year's 18% year-on-year EBIT growth. So we are not troubled with Daehan Flour MillsLtd's debt use. 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. Consider for instance, the ever-present spectre of investment risk. We've identified 1 warning sign with Daehan Flour MillsLtd , 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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