Is Micro Digital (KOSDAQ:305090) Using Too Much Debt?

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.' 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. We can see that Micro Digital Co., Ltd. (KOSDAQ:305090) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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.

See our latest analysis for Micro Digital

How Much Debt Does Micro Digital Carry?

As you can see below, at the end of September 2020, Micro Digital had ₩5.10b of debt, up from ₩1.01b a year ago. Click the image for more detail. However, it does have ₩7.68b in cash offsetting this, leading to net cash of ₩2.58b.

How Healthy Is Micro Digital's Balance Sheet?

The latest balance sheet data shows that Micro Digital had liabilities of ₩6.06b due within a year, and liabilities of ₩4.32b falling due after that. Offsetting these obligations, it had cash of ₩7.68b as well as receivables valued at ₩1.38b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₩1.33b.

Having regard to Micro Digital's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the ₩108.2b company is struggling for cash, we still think it's worth monitoring its balance sheet. While it does have liabilities worth noting, Micro Digital also has more cash than debt, so we're pretty confident it can manage its debt safely. There's no doubt that we learn most about debt from the balance sheet. But it is Micro Digital's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, Micro Digital made a loss at the EBIT level, and saw its revenue drop to ₩2.5b, which is a fall of 54%. That makes us nervous, to say the least.

So How Risky Is Micro Digital?

We have no doubt that loss making companies are, in general, riskier than profitable ones. And in the last year Micro Digital had an earnings before interest and tax (EBIT) loss, truth be told. Indeed, in that time it burnt through ₩9.2b of cash and made a loss of ₩5.3b. But at least it has ₩2.58b on the balance sheet to spend on growth, near-term. Overall, we'd say the stock is a bit risky, and we're usually very cautious until we see positive free cash flow. 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. For instance, we've identified 6 warning signs for Micro Digital (1 can't be ignored) you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

If you decide to trade Micro Digital, use the lowest-cost* platform that is rated #1 Overall by Barron’s, Interactive Brokers. Trade stocks, options, futures, forex, bonds and funds on 135 markets, all from a single integrated account. Promoted

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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.