Is Daesung Microbiological Labs (KOSDAQ:036480) A Risky Investment?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Daesung Microbiological Labs. Co., Ltd. (KOSDAQ:036480) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Daesung Microbiological Labs

What Is Daesung Microbiological Labs's Debt?

The image below, which you can click on for greater detail, shows that at September 2020 Daesung Microbiological Labs had debt of ₩17.1b, up from ₩5.20b in one year. On the flip side, it has ₩11.9b in cash leading to net debt of about ₩5.14b.

How Healthy Is Daesung Microbiological Labs' Balance Sheet?

We can see from the most recent balance sheet that Daesung Microbiological Labs had liabilities of ₩2.63b falling due within a year, and liabilities of ₩18.0b due beyond that. On the other hand, it had cash of ₩11.9b and ₩3.65b worth of receivables due within a year. So its liabilities total ₩5.02b more than the combination of its cash and short-term receivables.

Of course, Daesung Microbiological Labs has a market capitalization of ₩87.8b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Daesung Microbiological Labs has a low debt to EBITDA ratio of only 0.93. And remarkably, despite having net debt, it actually received more in interest over the last twelve months than it had to pay. So there's no doubt this company can take on debt while staying cool as a cucumber. Fortunately, Daesung Microbiological Labs grew its EBIT by 2.4% in the last year, making that debt load look even more manageable. 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 Daesung Microbiological Labs 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Daesung Microbiological Labs saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Based on what we've seen Daesung Microbiological Labs is not finding it easy, given its conversion of EBIT to free cash flow, but the other factors we considered give us cause to be optimistic. There's no doubt that its ability to to cover its interest expense with its EBIT is pretty flash. Looking at all this data makes us feel a little cautious about Daesung Microbiological Labs's debt levels. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. 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. Be aware that Daesung Microbiological Labs is showing 6 warning signs in our investment analysis , and 3 of those are significant...

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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