We Think NPC (KRX:004250) Can Stay On Top Of Its Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, NPC Co., Ltd. (KRX:004250) does carry debt. But the more important question is: how much risk is that debt creating?

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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for NPC

How Much Debt Does NPC Carry?

You can click the graphic below for the historical numbers, but it shows that NPC had ₩65.5b of debt in September 2020, down from ₩78.0b, one year before. However, it does have ₩63.7b in cash offsetting this, leading to net debt of about ₩1.86b.

A Look At NPC's Liabilities

We can see from the most recent balance sheet that NPC had liabilities of ₩100.3b falling due within a year, and liabilities of ₩18.3b due beyond that. Offsetting these obligations, it had cash of ₩63.7b as well as receivables valued at ₩69.8b due within 12 months. So it actually has ₩14.8b more liquid assets than total liabilities.

This surplus suggests that NPC has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Carrying virtually no net debt, NPC has a very light debt load indeed.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

NPC has very little debt (net of cash), and boasts a debt to EBITDA ratio of 0.033 and EBIT of 36.2 times the interest expense. Indeed relative to its earnings its debt load seems light as a feather. The modesty of its debt load may become crucial for NPC if management cannot prevent a repeat of the 21% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But it is NPC's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, NPC's free cash flow amounted to 28% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

Based on what we've seen NPC is not finding it easy, given its EBIT growth rate, but the other factors we considered give us cause to be optimistic. In particular, we are dazzled with its interest cover. Considering this range of data points, we think NPC is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. 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. Take risks, for example - NPC has 2 warning signs (and 1 which is concerning) we think you should know about.

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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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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