Amorepacific (KRX:090430) Seems To Use Debt Quite Sensibly

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Amorepacific Corporation (KRX:090430) does use debt in its business. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Amorepacific

What Is Amorepacific's Debt?

The chart below, which you can click on for greater detail, shows that Amorepacific had ₩115.9b in debt in September 2020; about the same as the year before. But it also has ₩787.9b in cash to offset that, meaning it has ₩672.0b net cash.

A Look At Amorepacific's Liabilities

The latest balance sheet data shows that Amorepacific had liabilities of ₩906.7b due within a year, and liabilities of ₩308.5b falling due after that. Offsetting this, it had ₩787.9b in cash and ₩404.6b in receivables that were due within 12 months. So its total liabilities are just about perfectly matched by its shorter-term, liquid assets.

This state of affairs indicates that Amorepacific's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the ₩12t company is struggling for cash, we still think it's worth monitoring its balance sheet. Despite its noteworthy liabilities, Amorepacific boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Amorepacific if management cannot prevent a repeat of the 51% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Amorepacific can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Amorepacific 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. Over the most recent three years, Amorepacific recorded free cash flow worth 56% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Amorepacific has ₩672.0b in net cash. So we don't have any problem with Amorepacific's use of debt. 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. Case in point: We've spotted 2 warning signs for Amorepacific you should be aware of.

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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