These 4 Measures Indicate That Dongnam Chemical (KRX:023450) Is Using Debt Safely

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.' 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. We can see that Dongnam Chemical Co., LTD. (KRX:023450) does use debt in its business. 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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Dongnam Chemical

What Is Dongnam Chemical's Debt?

You can click the graphic below for the historical numbers, but it shows that Dongnam Chemical had ₩6.56b of debt in September 2020, down from ₩17.8b, one year before. However, it does have ₩13.1b in cash offsetting this, leading to net cash of ₩6.54b.

How Healthy Is Dongnam Chemical's Balance Sheet?

According to the last reported balance sheet, Dongnam Chemical had liabilities of ₩14.4b due within 12 months, and liabilities of ₩4.52b due beyond 12 months. Offsetting these obligations, it had cash of ₩13.1b as well as receivables valued at ₩16.1b due within 12 months. So it actually has ₩10.3b more liquid assets than total liabilities.

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

In addition to that, we're happy to report that Dongnam Chemical has boosted its EBIT by 59%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Dongnam Chemical 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, a company can only pay off debt with cold hard cash, not accounting profits. While Dongnam Chemical 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. During the last three years, Dongnam Chemical generated free cash flow amounting to a very robust 86% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Dongnam Chemical has net cash of ₩6.54b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of ₩10b, being 86% of its EBIT. So is Dongnam Chemical's debt a risk? It doesn't seem so to us. 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 Dongnam Chemical is showing 2 warning signs 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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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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