Stock Analysis

Does Futurestream Networks (KOSDAQ:214270) Have A Healthy Balance Sheet?

KOSDAQ:A214270
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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 note that Futurestream Networks Co., Ltd. (KOSDAQ:214270) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

See our latest analysis for Futurestream Networks

What Is Futurestream Networks's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Futurestream Networks had ₩44.6b of debt, an increase on ₩33.3b, over one year. On the flip side, it has ₩30.2b in cash leading to net debt of about ₩14.4b.

debt-equity-history-analysis
KOSDAQ:A214270 Debt to Equity History January 13th 2021

How Healthy Is Futurestream Networks' Balance Sheet?

The latest balance sheet data shows that Futurestream Networks had liabilities of ₩91.0b due within a year, and liabilities of ₩38.5b falling due after that. Offsetting these obligations, it had cash of ₩30.2b as well as receivables valued at ₩76.4b due within 12 months. So its liabilities total ₩22.8b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Futurestream Networks has a market capitalization of ₩103.9b, and so it could probably strengthen its balance sheet by raising capital if it needed to. 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Even though Futurestream Networks's debt is only 1.7, its interest cover is really very low at 0.28. The main reason for this is that it has such high depreciation and amortisation. While companies often boast that these charges are non-cash, most such businesses will therefore require ongoing investment (that is not expensed.) In any case, it's safe to say the company has meaningful debt. Importantly, Futurestream Networks's EBIT fell a jaw-dropping 84% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. 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 Futurestream Networks will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, Futurestream Networks's free cash flow amounted to 46% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

To be frank both Futurestream Networks's interest cover and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. But at least its net debt to EBITDA is not so bad. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Futurestream Networks stock a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 1 warning sign for Futurestream Networks you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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