Here's Why Ray (KOSDAQ:228670) Can Manage Its Debt Responsibly

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.' 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 Ray Co., Ltd. (KOSDAQ:228670) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Ray

What Is Ray's Debt?

The image below, which you can click on for greater detail, shows that at September 2020 Ray had debt of ₩8.35b, up from ₩967.7m in one year. However, it does have ₩24.3b in cash offsetting this, leading to net cash of ₩15.9b.

How Healthy Is Ray's Balance Sheet?

We can see from the most recent balance sheet that Ray had liabilities of ₩19.1b falling due within a year, and liabilities of ₩6.91b due beyond that. Offsetting these obligations, it had cash of ₩24.3b as well as receivables valued at ₩17.0b due within 12 months. So it can boast ₩15.3b more liquid assets than total liabilities.

This short term liquidity is a sign that Ray could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Ray has more cash than debt is arguably a good indication that it can manage its debt safely.

It is just as well that Ray's load is not too heavy, because its EBIT was down 56% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Ray's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Ray 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 two years, Ray recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Ray has net cash of ₩15.9b, as well as more liquid assets than liabilities. So we don't have any problem with Ray's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Consider for instance, the ever-present spectre of investment risk. We've identified 1 warning sign with Ray , and understanding them should be part of your investment process.

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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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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