Does Dong Yang Steel Pipe (KRX:008970) Have A Healthy Balance Sheet?

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. We can see that Dong Yang Steel Pipe Co., Ltd. (KRX:008970) does use debt in its business. But the real question is whether this debt is making the company risky.

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. 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, 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.

View our latest analysis for Dong Yang Steel Pipe

How Much Debt Does Dong Yang Steel Pipe Carry?

The chart below, which you can click on for greater detail, shows that Dong Yang Steel Pipe had ₩35.1b in debt in June 2020; about the same as the year before. However, it also had ₩9.37b in cash, and so its net debt is ₩25.7b.

How Healthy Is Dong Yang Steel Pipe's Balance Sheet?

The latest balance sheet data shows that Dong Yang Steel Pipe had liabilities of ₩62.7b due within a year, and liabilities of ₩9.10b falling due after that. Offsetting this, it had ₩9.37b in cash and ₩34.8b in receivables that were due within 12 months. So it has liabilities totalling ₩27.6b more than its cash and near-term receivables, combined.

Dong Yang Steel Pipe has a market capitalization of ₩131.4b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Dong Yang Steel Pipe has net debt worth 1.7 times EBITDA, which isn't too much, but its interest cover looks a bit on the low side, with EBIT at only 6.7 times the interest expense. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. It was also good to see that despite losing money on the EBIT line last year, Dong Yang Steel Pipe turned things around in the last 12 months, delivering and EBIT of ₩8.3b. 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 Dong Yang Steel Pipe will need earnings to service that debt. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Over the most recent year, Dong Yang Steel Pipe recorded free cash flow worth 69% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

Dong Yang Steel Pipe's conversion of EBIT to free cash flow suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And we also thought its interest cover was a positive. All these things considered, it appears that Dong Yang Steel Pipe can comfortably handle its current debt levels. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. 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. Case in point: We've spotted 1 warning sign for Dong Yang Steel Pipe you should be aware of.

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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