Here's Why Dongwha EnterpriseLtd (KOSDAQ:025900) Has A Meaningful Debt Burden

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. As with many other companies Dongwha Enterprise Co.,Ltd (KOSDAQ:025900) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Dongwha EnterpriseLtd

What Is Dongwha EnterpriseLtd's Debt?

As you can see below, at the end of December 2020, Dongwha EnterpriseLtd had ₩597.3b of debt, up from ₩509.0b a year ago. Click the image for more detail. However, because it has a cash reserve of ₩80.8b, its net debt is less, at about ₩516.5b.

A Look At Dongwha EnterpriseLtd's Liabilities

According to the last reported balance sheet, Dongwha EnterpriseLtd had liabilities of ₩446.0b due within 12 months, and liabilities of ₩439.3b due beyond 12 months. On the other hand, it had cash of ₩80.8b and ₩168.5b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₩636.1b.

This deficit isn't so bad because Dongwha EnterpriseLtd is worth ₩1.32t, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Dongwha EnterpriseLtd's debt is 4.3 times its EBITDA, and its EBIT cover its interest expense 6.4 times over. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. If Dongwha EnterpriseLtd can keep growing EBIT at last year's rate of 15% over the last year, then it will find its debt load easier to manage. 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're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, Dongwha EnterpriseLtd created free cash flow amounting to 5.9% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

While Dongwha EnterpriseLtd's net debt to EBITDA makes us cautious about it, its track record of converting EBIT to free cash flow is no better. At least its EBIT growth rate gives us reason to be optimistic. Taking the abovementioned factors together we do think Dongwha EnterpriseLtd's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. 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. Be aware that Dongwha EnterpriseLtd is showing 3 warning signs in our investment analysis , you should know about...

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. 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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