We Think Dong Yang Steel Pipe (KRX:008970) Is Taking Some Risk With Its 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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Dong Yang Steel Pipe Co., Ltd. (KRX:008970) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Dong Yang Steel Pipe

What Is Dong Yang Steel Pipe's Net Debt?

The image below, which you can click on for greater detail, shows that Dong Yang Steel Pipe had debt of ₩63.1b at the end of June 2024, a reduction from ₩82.3b over a year. However, it does have ₩20.6b in cash offsetting this, leading to net debt of about ₩42.5b.

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

According to the last reported balance sheet, Dong Yang Steel Pipe had liabilities of ₩93.9b due within 12 months, and liabilities of ₩7.32b due beyond 12 months. Offsetting this, it had ₩20.6b in cash and ₩52.0b in receivables that were due within 12 months. So it has liabilities totalling ₩28.6b more than its cash and near-term receivables, combined.

This deficit isn't so bad because Dong Yang Steel Pipe is worth ₩115.6b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). 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).

While we wouldn't worry about Dong Yang Steel Pipe's net debt to EBITDA ratio of 3.2, we think its super-low interest cover of 1.4 times is a sign of high leverage. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. Looking on the bright side, Dong Yang Steel Pipe boosted its EBIT by a silky 99% in the last year. Like a mother's loving embrace of a newborn that sort of growth builds resilience, putting the company in a stronger position to manage its debt. There's no doubt that we learn most about debt from the balance sheet. But it is Dong Yang Steel Pipe'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 we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Dong Yang Steel Pipe burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Dong Yang Steel Pipe's conversion of EBIT to free cash flow and interest cover definitely weigh on it, in our esteem. But its EBIT growth rate tells a very different story, and suggests some resilience. Taking the abovementioned factors together we do think Dong Yang Steel Pipe's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. 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. Be aware that Dong Yang Steel Pipe is showing 3 warning signs in our investment analysis , and 1 of those can't be ignored...

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. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.