Is Busan Industrial (KRX:011390) A Risky Investment?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Busan Industrial Co., Ltd. (KRX:011390) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Busan Industrial

How Much Debt Does Busan Industrial Carry?

The image below, which you can click on for greater detail, shows that Busan Industrial had debt of ₩9.60b at the end of December 2020, a reduction from ₩12.0b over a year. However, it does have ₩17.9b in cash offsetting this, leading to net cash of ₩8.27b.

How Strong Is Busan Industrial's Balance Sheet?

According to the last reported balance sheet, Busan Industrial had liabilities of ₩40.4b due within 12 months, and liabilities of ₩7.14b due beyond 12 months. Offsetting these obligations, it had cash of ₩17.9b as well as receivables valued at ₩22.6b due within 12 months. So its liabilities total ₩7.06b more than the combination of its cash and short-term receivables.

Given Busan Industrial has a market capitalization of ₩139.4b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Busan Industrial also has more cash than debt, so we're pretty confident it can manage its debt safely.

It is just as well that Busan Industrial's load is not too heavy, because its EBIT was down 47% 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 you can't view debt in total isolation; since Busan Industrial 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Busan Industrial 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. Happily for any shareholders, Busan Industrial actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Busan Industrial has ₩8.27b in net cash. And it impressed us with free cash flow of ₩8.1b, being 126% of its EBIT. So we don't have any problem with Busan Industrial's use of debt. 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. Be aware that Busan Industrial is showing 1 warning sign in our investment analysis , 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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