These 4 Measures Indicate That Pearl Abyss (KOSDAQ:263750) Is Using Debt Safely

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. As with many other companies Pearl Abyss Corp. (KOSDAQ:263750) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Pearl Abyss

How Much Debt Does Pearl Abyss Carry?

As you can see below, at the end of September 2019, Pearl Abyss had ₩189.4b of debt, up from ₩155.9k a year ago. Click the image for more detail. However, its balance sheet shows it holds ₩411.7b in cash, so it actually has ₩222.2b net cash.

How Healthy Is Pearl Abyss's Balance Sheet?

The latest balance sheet data shows that Pearl Abyss had liabilities of ₩165.9b due within a year, and liabilities of ₩188.5b falling due after that. Offsetting this, it had ₩411.7b in cash and ₩77.5b in receivables that were due within 12 months. So it actually has ₩134.8b more liquid assets than total liabilities.

This short term liquidity is a sign that Pearl Abyss could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Pearl Abyss boasts net cash, so it's fair to say it does not have a heavy debt load!

Pearl Abyss's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Pearl Abyss can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Pearl Abyss 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. Over the last three years, Pearl Abyss recorded free cash flow worth a fulsome 96% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing up

While it is always sensible to investigate a company's debt, in this case Pearl Abyss has ₩222.2b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of ₩165b, being 96% of its EBIT. So is Pearl Abyss'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. Consider for instance, the ever-present spectre of investment risk. We've identified 2 warning signs with Pearl Abyss , and understanding them should be part of your investment process.

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.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned.

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