Dongwha EnterpriseLtd (KOSDAQ:025900) Has A Somewhat Strained 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. Importantly, Dongwha Enterprise Co.,Ltd (KOSDAQ:025900) does carry debt. But the more important question is: how much risk is that debt creating?

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When Is Debt A Problem?

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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Dongwha EnterpriseLtd's Net Debt?

The image below, which you can click on for greater detail, shows that at December 2024 Dongwha EnterpriseLtd had debt of ₩912.4b, up from ₩800.8b in one year. However, it does have ₩111.6b in cash offsetting this, leading to net debt of about ₩800.8b.

How Strong Is Dongwha EnterpriseLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Dongwha EnterpriseLtd had liabilities of ₩778.2b due within 12 months and liabilities of ₩604.0b due beyond that. On the other hand, it had cash of ₩111.6b and ₩116.1b worth of receivables due within a year. So it has liabilities totalling ₩1.15t more than its cash and near-term receivables, combined.

This deficit casts a shadow over the ₩385.1b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Dongwha EnterpriseLtd would likely require a major re-capitalisation if it had to pay its creditors today.

View our latest analysis for Dongwha EnterpriseLtd

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Dongwha EnterpriseLtd shareholders face the double whammy of a high net debt to EBITDA ratio (9.7), and fairly weak interest coverage, since EBIT is just 0.33 times the interest expense. The debt burden here is substantial. However, the silver lining was that Dongwha EnterpriseLtd achieved a positive EBIT of ₩14b in the last twelve months, an improvement on the prior year's loss. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Dongwha EnterpriseLtd'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, Dongwha EnterpriseLtd actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

On the face of it, Dongwha EnterpriseLtd's interest cover left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. 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. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for Dongwha EnterpriseLtd you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.