Does Daesang Holdings (KRX:084690) Have A Healthy Balance Sheet?

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. Importantly, Daesang Holdings Co., Ltd. (KRX:084690) does carry debt. 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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 Daesang Holdings

What Is Daesang Holdings's Net Debt?

As you can see below, at the end of December 2020, Daesang Holdings had ₩943.9b of debt, up from ₩893.8b a year ago. Click the image for more detail. On the flip side, it has ₩659.1b in cash leading to net debt of about ₩284.8b.

A Look At Daesang Holdings' Liabilities

According to the last reported balance sheet, Daesang Holdings had liabilities of ₩942.3b due within 12 months, and liabilities of ₩791.9b due beyond 12 months. On the other hand, it had cash of ₩659.1b and ₩363.8b worth of receivables due within a year. So it has liabilities totalling ₩711.3b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the ₩414.7b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, Daesang Holdings would likely require a major re-capitalisation if it had to pay its creditors today.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Daesang Holdings has a low net debt to EBITDA ratio of only 0.77. And its EBIT easily covers its interest expense, being 13.7 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. On top of that, Daesang Holdings grew its EBIT by 61% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But it is Daesang Holdings's earnings that will influence how the balance sheet holds up in the future. 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. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, Daesang Holdings created free cash flow amounting to 9.2% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

While Daesang Holdings's level of total liabilities has us nervous. For example, its interest cover and EBIT growth rate give us some confidence in its ability to manage its debt. Taking the abovementioned factors together we do think Daesang Holdings's debt poses some risks to the business. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. 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. For example Daesang Holdings has 2 warning signs (and 1 which makes us a bit uncomfortable) we think you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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