Does Dongwha EnterpriseLtd (KOSDAQ:025900) Have A Healthy Balance Sheet?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Dongwha Enterprise Co.,Ltd (KOSDAQ:025900) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Dongwha EnterpriseLtd

How Much Debt Does Dongwha EnterpriseLtd Carry?

The image below, which you can click on for greater detail, shows that at September 2024 Dongwha EnterpriseLtd had debt of ₩918.2b, up from ₩830.0b in one year. However, because it has a cash reserve of ₩138.8b, its net debt is less, at about ₩779.4b.

A Look At Dongwha EnterpriseLtd's Liabilities

We can see from the most recent balance sheet that Dongwha EnterpriseLtd had liabilities of ₩807.7b falling due within a year, and liabilities of ₩599.3b due beyond that. On the other hand, it had cash of ₩138.8b and ₩92.9b worth of receivables due within a year. So it has liabilities totalling ₩1.18t more than its cash and near-term receivables, combined.

This deficit casts a shadow over the ₩387.4b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Dongwha EnterpriseLtd 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.

Weak interest cover of 0.29 times and a disturbingly high net debt to EBITDA ratio of 9.6 hit our confidence in Dongwha EnterpriseLtd like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. However, the silver lining was that Dongwha EnterpriseLtd achieved a positive EBIT of ₩12b in the last twelve months, an improvement on the prior year's loss. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Dongwha EnterpriseLtd 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Happily for any shareholders, Dongwha EnterpriseLtd actually produced more free cash flow than EBIT over the last year. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

To be frank both Dongwha EnterpriseLtd's interest cover and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. Overall, it seems to us that Dongwha EnterpriseLtd's balance sheet is really quite a risk to the business. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 2 warning signs we've spotted with Dongwha EnterpriseLtd (including 1 which shouldn't be ignored) .

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.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.