Here's Why exax (KOSDAQ:060230) Can Manage Its Debt Responsibly

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 can see that exax Inc. (KOSDAQ:060230) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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.

Check out our latest analysis for exax

What Is exax's Net Debt?

As you can see below, exax had ₩22.3b of debt at December 2020, down from ₩25.8b a year prior. However, it does have ₩33.2b in cash offsetting this, leading to net cash of ₩10.9b.

How Strong Is exax's Balance Sheet?

According to the last reported balance sheet, exax had liabilities of ₩22.2b due within 12 months, and liabilities of ₩6.70b due beyond 12 months. Offsetting these obligations, it had cash of ₩33.2b as well as receivables valued at ₩14.5b due within 12 months. So it actually has ₩18.8b more liquid assets than total liabilities.

This excess liquidity suggests that exax is taking a careful approach to debt. Due to its strong net asset position, it is not likely to face issues with its lenders. Succinctly put, exax boasts net cash, so it's fair to say it does not have a heavy debt load!

Shareholders should be aware that exax's EBIT was down 88% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since exax will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While exax 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 last three years, exax 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.

Summing up

While it is always sensible to investigate a company's debt, in this case exax has ₩10.9b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of ₩2.9b, being 346% of its EBIT. So we don't have any problem with exax's use of debt. 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. We've identified 1 warning sign with exax , and understanding them should be part of your investment process.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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