Is Daejung Chemicals & MetalsLtd (KOSDAQ:120240) Using Too Much Debt?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Daejung Chemicals & Metals Co.,Ltd. (KOSDAQ:120240) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Daejung Chemicals & MetalsLtd

How Much Debt Does Daejung Chemicals & MetalsLtd Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Daejung Chemicals & MetalsLtd had ₩18.0b of debt, an increase on ₩6.20b, over one year. However, its balance sheet shows it holds ₩43.3b in cash, so it actually has ₩25.3b net cash.

How Strong Is Daejung Chemicals & MetalsLtd's Balance Sheet?

We can see from the most recent balance sheet that Daejung Chemicals & MetalsLtd had liabilities of ₩29.6b falling due within a year, and liabilities of ₩5.79b due beyond that. Offsetting this, it had ₩43.3b in cash and ₩15.2b in receivables that were due within 12 months. So it actually has ₩23.1b more liquid assets than total liabilities.

This short term liquidity is a sign that Daejung Chemicals & MetalsLtd could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Daejung Chemicals & MetalsLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

Daejung Chemicals & MetalsLtd's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is Daejung Chemicals & MetalsLtd's earnings that will influence how the balance sheet holds up in the future. 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 Daejung Chemicals & MetalsLtd 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. Considering the last three years, Daejung Chemicals & MetalsLtd actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Daejung Chemicals & MetalsLtd has net cash of ₩25.3b, as well as more liquid assets than liabilities. So we don't have any problem with Daejung Chemicals & MetalsLtd'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. For instance, we've identified 3 warning signs for Daejung Chemicals & MetalsLtd that 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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