Is Ray (KOSDAQ:228670) Using Too Much Debt?

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Ray Co., Ltd. (KOSDAQ:228670) does carry debt. But is this debt a concern to shareholders?

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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Ray

How Much Debt Does Ray Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Ray had ₩8.35b of debt, an increase on ₩967.7m, over 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 this, it had ₩24.3b in cash and ₩17.0b in receivables that were due within 12 months. So it actually has ₩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 ultimately the future profitability of the business will decide if Ray can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Ray 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. Considering the last two years, Ray actually recorded a cash outflow, overall. 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 it is always sensible to investigate a company's debt, in this case Ray has ₩15.9b in net cash and a decent-looking balance sheet. So we are not troubled with Ray's debt use. 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. To that end, you should be aware of the 1 warning sign we've spotted with Ray .

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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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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