These 4 Measures Indicate That NongShim HoldingsLtd (KRX:072710) Is Using Debt Reasonably Well

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 NongShim Holdings Co.,Ltd. (KRX:072710) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for NongShim HoldingsLtd

What Is NongShim HoldingsLtd's Net Debt?

The image below, which you can click on for greater detail, shows that NongShim HoldingsLtd had debt of ₩93.0b at the end of September 2020, a reduction from ₩134.4b over a year. However, it also had ₩30.4b in cash, and so its net debt is ₩62.6b.

How Healthy Is NongShim HoldingsLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that NongShim HoldingsLtd had liabilities of ₩258.4b due within 12 months and liabilities of ₩48.6b due beyond that. Offsetting these obligations, it had cash of ₩30.4b as well as receivables valued at ₩114.4b due within 12 months. So its liabilities total ₩162.2b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because NongShim HoldingsLtd is worth ₩346.0b, 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.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

NongShim HoldingsLtd's net debt is only 0.79 times its EBITDA. And its EBIT easily covers its interest expense, being 41.7 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. In addition to that, we're happy to report that NongShim HoldingsLtd has boosted its EBIT by 66%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since NongShim HoldingsLtd 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. So it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, NongShim HoldingsLtd's free cash flow amounted to 37% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

Happily, NongShim HoldingsLtd's impressive interest cover implies it has the upper hand on its debt. But truth be told we feel its level of total liabilities does undermine this impression a bit. Looking at all the aforementioned factors together, it strikes us that NongShim HoldingsLtd can handle its debt fairly comfortably. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. 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. Be aware that NongShim HoldingsLtd is showing 1 warning sign in our investment analysis , you should know about...

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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