Does KG Dongbu SteelLtd (KRX:016380) Have A Healthy Balance Sheet?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 KG Dongbu Steel Co.,Ltd. (KRX:016380) makes use of debt. But should shareholders be worried about its use of debt?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for KG Dongbu SteelLtd

What Is KG Dongbu SteelLtd's Net Debt?

As you can see below, KG Dongbu SteelLtd had ₩968.9b of debt, at September 2024, which is about the same as the year before. You can click the chart for greater detail. However, it also had ₩443.5b in cash, and so its net debt is ₩525.3b.

A Look At KG Dongbu SteelLtd's Liabilities

The latest balance sheet data shows that KG Dongbu SteelLtd had liabilities of ₩636.8b due within a year, and liabilities of ₩727.9b falling due after that. On the other hand, it had cash of ₩443.5b and ₩330.3b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₩590.8b.

This deficit is considerable relative to its market capitalization of ₩686.4b, so it does suggest shareholders should keep an eye on KG Dongbu SteelLtd's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

KG Dongbu SteelLtd's net debt is sitting at a very reasonable 2.1 times its EBITDA, while its EBIT covered its interest expense just 6.5 times last year. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. Shareholders should be aware that KG Dongbu SteelLtd's EBIT was down 30% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine KG Dongbu SteelLtd's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. During the last three years, KG Dongbu SteelLtd generated free cash flow amounting to a very robust 95% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Our View

KG Dongbu SteelLtd's EBIT growth rate and level of total liabilities definitely weigh on it, in our esteem. But the good news is it seems to be able to convert EBIT to free cash flow with ease. When we consider all the factors discussed, it seems to us that KG Dongbu SteelLtd is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - KG Dongbu SteelLtd has 1 warning sign we think you should be aware of.

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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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.