Is DONGBANGRO (KRX:007590) Using Too Much Debt?

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.' 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. As with many other companies DONGBANG AGRO Corporation (KRX:007590) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for DONGBANGRO

What Is DONGBANGRO's Net Debt?

The image below, which you can click on for greater detail, shows that at December 2020 DONGBANGRO had debt of ₩2.24b, up from none in one year. However, it does have ₩49.2b in cash offsetting this, leading to net cash of ₩46.9b.

A Look At DONGBANGRO's Liabilities

The latest balance sheet data shows that DONGBANGRO had liabilities of ₩33.3b due within a year, and liabilities of ₩20.9b falling due after that. Offsetting these obligations, it had cash of ₩49.2b as well as receivables valued at ₩15.2b due within 12 months. So it actually has ₩10.1b more liquid assets than total liabilities.

This surplus suggests that DONGBANGRO has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that DONGBANGRO has more cash than debt is arguably a good indication that it can manage its debt safely.

Also good is that DONGBANGRO grew its EBIT at 19% over the last year, further increasing its ability to manage debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is DONGBANGRO'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. DONGBANGRO may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. In the last three years, DONGBANGRO's free cash flow amounted to 28% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that DONGBANGRO has net cash of ₩46.9b, as well as more liquid assets than liabilities. And we liked the look of last year's 19% year-on-year EBIT growth. So we don't think DONGBANGRO's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for DONGBANGRO that you should be aware of before investing here.

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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